Statement #4/Managerial Cost Accounting Concepts and Standards

Statement #4/Managerial Cost Accounting Concepts and Standardsfor the Federal Government

Executive Office of the PresidentOffice of Management and Budget

"Managerial Cost Accounting Concepts andStandards for the Federal Government"

Statement of Federal Financial Accounting StandardsNumber 4

July 31, 1995

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TABLE OF CONTNETS

EXECUTIVE SUMMARY (paragraphs 1-12)

INTRODUCTION (paragraphs 13-30)

BackgroundUsers of Federal Government Cost InformationObjectivesTerminologyMaterialityEffective Date

PURPOSES OF USING COST INFORMATION (paragraphs 31-40)

Budgeting and Cost ControlPerformance MeasurementDetermining Reimbursements and Setting Fees and PricesProgram EvaluationsEconomic Choice Decisions

This is the original Standard file; please check for the most recent update in the FASAB Handbook at www.fasab.gov/pdffiles/handbook_sffas_4.pdf.

MANAGERIAL COST ACCOUNTING CONCEPTS (paragraphs 41-66)

MANAGERIAL COST ACCOUNTING STANDARDS (paragraphs 67-162)Requirement for Cost Accounting (paragraphs 67-76)

Responsibility Segments (paragraphs 77-88)Full Cost (paragraphs 89-104)

Inter-Entity Costs (paragraphs 105-115)

Costing Methodology (paragraphs 116-162)

APPENDIX A: Basis for Conclusions (paragraphs 163-270)

APPENDIX B: Glossary

*******************************************************EXECUTIVE SUMMARY

1. The managerial cost accounting concepts and standards contained in this statement are aimed at providing reliable and timely information on the full cost of federal programs, their activities, and outputs. The cost information can be used by the Congress and federal executives in making decisions about allocating federal resources, authorizing and modifying programs, and evaluating program performance. The cost information can also be used by program managers in making managerial decisions to improve operating economy and efficiency.

2. The concepts of managerial cost accounting contained in this statement describe the relationship among cost accounting, financial reporting, and budgeting. The five standards set forth the fundamental elements of managerial cost accounting: (1) accumulating and reporting costs of activities on a regular basis for management information purposes, (2) establishing responsibility segments to match costs with outputs, (3) determining full costs of government goods and services, (4) recognizing the costs of goods and services provided among federal


entities, and (5) using appropriate costing methodologies to accumulate and assign costs to outputs.

3. These standards are based on sound cost accounting concepts and are broad enough to allow maximum flexibility for agency managers to develop costing methods that are best suited to their operational environment. Also, the managerial cost accounting standards and practices will evolve and improve as agencies gain experience in using them. The following is a summary of the concepts and standards contained in this statement:

Managerial Cost Accounting Concepts

4. Managerial cost accounting should be a fundamental part of the financial management system and, to the extent practicable, should be integrated with other parts of the system. Managerial costing should use a basis of accounting, recognition, and measurement appropriate for the intended purpose. Cost information developed for different purposes should be drawn from a common data source, and output reports should be reconcilable to each other.

Managerial Cost Accounting Standards

Requirement for cost accounting

5. Each reporting entity should accumulate and report the costs of its activities on a regular basis for management information purposes. Costs may be accumulated either through the use of cost accounting systems or through the use of cost finding techniques.

Responsibility segments

6. Management of each reporting entity should define and establish responsibility segments. Managerial cost accounting should


be performed to measure and report the costs of each segment's outputs. Special cost studies, if necessary, should be performed to determine the costs of outputs.

Full cost

7. Reporting entities should report the full costs of outputs in general purpose financial reports. The full cost of an output produced by a responsibility segment is the sum of (1) the costs of resources consumed by the segment that directly or indirectly contribute to the output, and (2) the costs of identifiable supporting services provided by other responsibility segments within the reporting entity, and by other reporting entities.

Inter-entity costs

8. Each entity's full cost should incorporate the full cost of goods and services that it receives from other entities. The entity providing the goods or services has the responsibility to provide the receiving entity with information on the full cost of such goods or services either through billing or other advice.

9. Recognition of inter-entity costs that are not fully reimbursed is limited to material items that (1) are significant to the receiving entity, (2) form an integral or necessary part of the receiving entity's output, and (3) can be identified or matched to the receiving entity with reasonable precision. Broad and general support services provided by an entity to all or most other entities generally should not be recognized unless such services form a vital and integral part of the operations or output of the receiving entity.

Costing methodology

10. Costs of resources consumed by


responsibility segments should be accumulated by type of resource. Outputs produced by responsibility segments should be accumulated and, if practicable, measured in units. The full costs of resources that directly or indirectly contribute to the production of outputs should be assigned to outputs through costing methodologies or cost finding techniques that are most appropriate to the segment's operating environment and should be followed consistently.

11. The cost assignments should be performed using the following methods listed in the order of preference: (a) directly tracing costs wherever feasible and economically practicable, (b) assigning costs on a cause- and-effect basis, or (c) allocating costs on a reasonable and consistent basis.

12. These accounting standards need not be applied to items that are qualitatively and quantitatively immaterial. The Board recommends that the managerial accounting standards of this Statement become effective for fiscal periods beginning after September 30, 1996. Earlier implementation is encouraged.

***************************************************INTRODUCTION

Background

13. Reliable information on the costs of federal programs and activities is crucial for effective management of government operations. In Statement of Federal Financial Accounting Concepts (SFFAC) No. 1, Objectives of Federal Financial Reporting, issued in 1993, it is stated that the objectives of federal financial reporting are to provide useful information to assist internal and external users in assessing the budget integrity, operating performance, stewardship, and systems and control


of the federal government.[Footnote 1]

[Footnote 1: Statement of Federal Financial AccountingConcepts No. 1, "Objectives of Federal FinancialReporting" (September 2, 1993), pars. 110 and 111,pages 34-35.]

14. Managerial cost accounting is especially important for fulfilling the objective of assessing operating performance. In relation to that objective, it is stated in SFFAC No. 1 that federal financial reporting should provide information that helps users to determine:

-- Costs of specific programs and activities and the composition of, and changes in, those costs;

-- Efforts and accomplishments associated with federal programs and their changes over time and in relation to costs; and

-- Efficiency and effectiveness of the government's management of its assets and liabilities.[Footnote 2]

[Footnote 2: Ibid., pars. 126-130, pages 39-40.]

15. It is further stated in SFFAC No. 1 that "Thetopics of costs and performance measurement are relatedbecause it is by associating cost withactivities or cost objectives that accounting canmake much of its contribution to reporting onperformance."[Footnote 3] "Cost" is the monetaryvalue of resources used or sacrificed orliabilities incurred to achieve an objective, suchas to acquire or produce a good or to perform anactivity or service. Costs incurred may benefitcurrent and future periods. In financialaccounting and reporting, the costs that apply toan entity's operations for the current accountingperiod are recognized as expenses of that period.

[Footnote 3: Ibid., par. 192, page 63.]


16. The Chief Financial Officers Act of 1990includes among the functions of chief financialofficers "the development and reporting of costinformation" and "the systematic measurement ofperformance."[Footnote 4] In July 1993, Congresspassed the Government Performance and Results Act(GPRA) which mandates performance measurement byfederal agencies.[Footnote 5] In September 1993,in his report to the President on the NationalPerformance Review (NPR), Vice President Al Gorerecommended an action which required the FederalAccounting Standards Advisory Board to issue a setof cost accounting standards for all federalactivities.[Footnote 6] Those standards willprovide a method for identifying the unit cost ofall government activities.

[Footnote 4: 104 Stat. 2938 (See particularly 31U.S.C. sec 902).]

[Footnote 5: 107 Stat. 285 (See particularly, 31U.S.C. sections 1101, 1105, 1115, 1116-1119, 9703,9704).]

[Footnote 6: Vice President Al Gore, "Creating AGovernment That Works Better & Costs Less,"Accompanying Report of the National Performance Review(September 1993), p. 59.]

17. In early 1994, the Federal AccountingStandards Advisory Board (the Board) convened anadvisory group to help develop standards formanagerial cost accounting in the federalgovernment. The group included members fromgovernment, business, and academe. Their viewsand proposals have been considered by the Board,and their work contributed greatly in developingthis document.

Users of FederalCost Information

18. The cost of government is a concern to thepublic as well as to the federal governmentitself. Most government service efforts andaccomplishments cannot be measured in financial


terms alone. Unlike private business, there is no"bottom line" or profit index to help measurepublic sector performance. However, governmentservice efforts and accomplishments can beevaluated using both financial and non-financialmeasures, and "cost" is an important financialmeasure for government programs. Internal andexternal federal information users identifiedbelow will find these standards helpful inassessing operating performance, stewardship,systems, and control of the federal government.

19. Government managers are the primary users ofcost information. They are responsible forcarrying out program objectives with resourcesentrusted to them. Reliable and timely costinformation helps them ensure that resources arespent to achieve expected results and outputs, andalerts them to waste and inefficiency.

20. Congress and federal executives, includingthe President, make policy decisions on programpriorities and allocate resources among programs.These officials need cost information to comparealternative courses of action and to make programauthorization decisions by assessing costs andbenefits. They also need cost information toevaluate program performance.

21. Citizens, including news media and interestgroups, are concerned with the costs and resultsof federal programs that affect their interests.They need program cost information to judgewhether resources are allocated to programsrationally and if the programs operate efficientlyand effectively.

Objectives

22. The managerial cost accounting concepts andstandards presented here are intended for all theuser groups identified above. These standards areaimed at achieving three general objectives:

-- Provide program managers [Footnote 7] with relevant and reliable information relating


costs to outputs and activities. Based on this information, program managers can respond to inquiries about the costs of the activities they manage. The cost information will assist them in improving operational economy and efficiency;

[Footnote 7: Statement of Federal Financial AccountingConcepts No.1, "Objectives of Financial Reporting,"defined "Program managers" as individuals who managefederal programs, and stated that "Their concernsinclude operating plans, program operations, and budgetexecution." SFFAC No. 1, par. 85, page 29. ]

-- Provide relevant and reliable cost information to assist the Congress and executives in making decisions about allocating federal resources, authorizing and modifying programs, and evaluating program performance; and

-- Ensure consistency between costs reported in general purpose financial reports and costs reported to program managers. This includes standardizing terminology for managerial cost accounting to improve communication among federal organizations and users of cost information.

Scope of Standards

23. This statement contains managerial costconcepts and five standards for the federalgovernment. The five standards address thefollowing topics:

(1) Requirement for cost accounting,(2) Responsibility segments,(3) Full cost,(4) Inter-entity costs, and(5) Costing methodology.

The essence of each standard is briefly stated ina box followed by detailed explanations. However,both the words in the boxes and the entire text of


explanations constitute the requirements of thestandards.

24. These standards are based on sound costaccounting concepts and allow sufficientflexibility for agencies to develop managerialcost accounting practices that are suited to theirspecific operating environments. Also, it isexpected that cost accounting standards andpractices will evolve and improve as agencies gainexperience in using them.

25. Other Statements of Federal FinancialAccounting Standards (SFFAS) address recognitionand measurement of assets and liabilities. Foradditional guidance, readers should consult: SFFASNo. 1, Accounting for Selected Assets andLiabilities; SFFAS No. 2, Accounting for DirectLoans and Loan Guarantees; and SFFAS No. 3,Accounting for Inventory and Related Property.The Board is working on and will soon completeother recognition and measurement projects relatedto revenues, liabilities, property, plant, andequipment, and other elements of financialstatements.[Footnote 8]

[Footnote 8: See FASAB Exposure Drafts, "Accountingfor Liabilities of the Federal Government" (November 7,1994); "Accounting for Property, Plant, and Equipment"(February 28, 1995); and "Revenue and Other FinancingSources" (Pending).]

Terminology

26. Managerial cost accounting information, to beuseful, must rely on consistent and uniformterminology for concepts, practices, andtechniques. Consistent and uniform use ofterminology can help avoid confusion and mis-communication among organizations and individuals.

27. As a start toward developing consistentmanagerial cost accounting terminology within thefederal government, this statement includes aglossary of basic cost accounting terms.


Materiality

28. Except as otherwise noted, the accounting andreporting provisions of these accounting standardsneed not be applied to items that arequalitatively and quantitatively immaterial.

29. The determination of whether an item ismaterial depends on the degree to which omittinginformation about the item makes it probable thatthe judgment of a reasonable person relying on theinformation would have been changed or influencedby the omission.

Effective Date

30. The Board recommends that the accountingstandards of this Statement become effective forfiscal periods beginning after September 30, 1996.Earlier implementation is encouraged.

Purposes of Using Cost Information

31. There are many different purposes for whichcost information may be used by the federalgovernment. The focus of this statement is oncost information needed to improve federalfinancial management and managerial decisionmaking.

32. In managing federal government programs, costinformation is essential in the following fiveareas: (1) budgeting and cost control, (2)performance measurement, (3) determiningreimbursements and setting fees and prices, (4)program evaluations, and (5) making economicchoice decisions. Each of these uses is discussedbelow.

Budgeting and Cost Control

33. Information on the costs of program activitiescan be used as a basis to estimate future costs in


preparing and reviewing budgets. Once budgets areapproved and executed, cost information serves asa feedback to budgets. Using cost information,federal managers can control and reduce costs, andfind and avoid waste. For example, withappropriate cost information, federal managerscan:

-- Compare costs with known or assumed benefits of activities, identify value-added and non- value-added activities, and make decisions to reduce resources devoted to activities that are not cost-effective;

-- Compare and determine reasons for variances between actual and budgeted costs of an activity or a product;

-- Compare cost changes over time and identify their causes;

-- Identify and reduce excess capacity costs; and

-- Compare costs of similar activities and find causes for cost differences, if any.

Performance Measurement

34. Measuring performance is a means of improvingprogram efficiency, effectiveness, and programresults. One of the stated purposes of the GPRAof 1993 is to ". . .improve the confidence of theAmerican people in the capability of the federalgovernment, by systematically holding federalagencies accountable for achieving programresults."

35. Measuring costs is an integral part ofmeasuring performance in terms of efficiency andcost-effectiveness. Efficiency is measured byrelating outputs to inputs. It is often expressedby the cost per unit of output. Whileeffectiveness in itself is measured by the outcomeor the degree to which a predetermined objectiveis met, it is commonly combined with cost


information to show "cost-effectiveness." Thus,the service efforts and accomplishments of agovernment entity can be evaluated with thefollowing measures:

(1) Measures of service efforts which include the costs of resources used to provide the services and non-financial measures;

(2) Measures of accomplishments which are outputs (the quantity of services provided) and outcomes (the results of those services); and

(3) Measures that relate efforts to accomplishments, Such as cost per unit of output or cost-effectiveness.

36. Thus, as stated previously, performancemeasurement requires both financial and non-financial measures. Cost is a necessary elementfor performance measurement, but is not the onlyelement.

Determining Reimbursementsand Setting Fees And Prices

37. Cost information is an important basis insetting fees and reimbursements. Pricing andcosting, however, are two different concepts.Setting prices is a policy matter, sometimesgoverned by statutory provisions and regulations,and other times by managerial or public policies.Thus, the price of a good or service does notnecessarily equal the cost of the good or theservice determined under a particular set ofprinciples. Nevertheless, cost is an importantconsideration in setting government prices. Withcertain exceptions, OMB requires: [Footnote 9]

[Footnote 9: OMB Circular A-25, User Charges (RevisedJuly 8, 1993).]

-- With respect to goods and services that the government provides in its sovereign capacity to a particular group of individuals as a special benefit, user charges should be


sufficient to recover the full cost of those goods and services; and

-- With respect to goods and services that the government provides under business-like conditions, user charges for those goods and services need not be limited to the recovery of full cost and may yield a net revenue.

38. Also, cost information is important incalculating reimbursements for products andservices provided by one government agency toanother. Even if fees or reimbursements do notrecover the full costs due to policy or economicconstraints, management needs to be aware of thedifference between cost and price. With thisinformation, program managers can properly informthe public, the Congress, and federal executivesabout the costs of providing the goods orservices.

Program Evaluations

39. Costs of federal resources required byprograms are an important factor in making policydecisions related to program authorization,modification, and discontinuation. Thesedecisions are usually subject to policyconstraints, and often require the considerationof social and economic costs and benefitsaffecting different sectors of the economy andsociety. Nevertheless, the costs of federalresources required are an important factor.Information on program costs can be used as abasis for cost-benefit considerations.

Economic Choice Decisions

40. Often, agencies and programs face decisionsinvolving choices among alternative actions, suchas whether to do a project in-house or contract itout; to accept or reject a proposal; or tocontinue or drop a product or service. Makingthese decisions requires cost comparisons amongavailable alternatives.


Managerial Cost Accounting Concepts

Managerial cost accounting should be a fundamentalpart of the financial management system and, to theextent practicable, should be integrated with otherparts of the system. Managerial costing should use abasis of accounting, recognition, and measurementappropriate for the intended purpose. Cost informationdeveloped for different purposes should be drawn from acommon data source, and output reports should bereconcilable to each other.

41. Managerial cost accounting should be anessential element of proper financial planning,control, and evaluation for any organization oractivity that uses resources having monetaryvalue. Managerial cost accounting is a basic partof the financial management system in that itsupports and provides data to the budgetary andfinancial accounting functions and, by itself,provides useful information for both internal andexternal users.

Role of Managerial CostAccounting in Financial Management

42. Managerial cost accounting is the process ofaccumulating, measuring, analyzing, interpreting,and reporting cost information useful to bothinternal and external groups concerned with theway in which the organization uses, accounts for,safeguards, and controls its resources to meet itsobjectives. Managerial cost accounting,therefore, is the servant of both budgetary andfinancial accounting and reporting because itassists those systems in providing information.Also, it provides useful information directly tomanagement. These relationships are shown inFigure 1.

Figure 1: Financial Management Information Framework


(Omitted, see hard copy)

Common Data Source

43. The information flow within a financialmanagement system begins with a basic informationpool or common data source. This data sourceconsists of all financial and programmaticinformation used by the budgetary, cost, andfinancial accounting processes. It includes allfinancial and much non-financial data, such asenvironmental data, that are necessary forbudgeting and financial reporting.[Footnote 10]The common data source also includes evaluationand decision information developed as a result ofprior reporting and feedback. Other types of datamay be included based upon perceived needs andpurposes related to the ultimate users of theinformation.

[Footnote 10: The makeup of core data andenvironmental data is discussed in Statement of FederalFinancial Accounting Concepts No. 1, "Objectives ofFederal Financial Reporting," Chapter 7, and,therefore, a detailed discussion is not provided here.]

44. The common data source may include manydifferent kinds of data. It is far more than theinformation about financial transactions found inthe standard general ledger, although that is asignificant part of the data source. Feworganizations or entities maintain all these datain any one system or location. Furthermore, theuse of the term "data source" is not meant toimply the use of computerized systems for sourceinformation. Instead, the term is used in a broadway to include many sources of information.

45. Managerial cost accounting, financialaccounting, and budgetary accounting drawinformation as needed from the common data source.The data obtained by each of these is processed toattain specific objectives by reporting useful


information.

Relationship to Financial Accounting

46. As shown in Figure 1 by their overlap,managerial cost accounting and financialaccounting are closely related or integrated. Tosome degree, this is due to the historicaldevelopment of cost accounting as a method formore detailed scorekeeping with the requirement toprovide inventory values for external financialreporting purposes.[Footnote 11] In part, it isbecause cost information generally originates withtransactions recorded for financial accountingpurposes.

[Footnote 11: Coulthurst, Nigel and John Piper, "TheState of Cost and Management Accounting," "ManagementAccounting," April 1986.]

47. While inventory valuation is still part ofthe fundamental relationship, managerial costaccounting serves financial accounting in severalother ways. Fundamentally, managerial costaccounting should assist financial accounting indetermining the results of operations during afiscal period by providing relevant data that areaccumulated to produce operating expenses. Thesedata include the allocation of capitalized coststo periods of time or units of usage.

48. Traditionally, managerial cost accountinginformation pertaining to financial accounting hasinvolved costs of past transactions and theassignment of transaction value to fiscal periodsand outputs. These purposes and uses are closelyaligned with the financial accounting activity andtraditional external financial reporting. Thispast cost aspect has been acknowledged inObjectives of Federal Financial Reporting whichstates that "financial accounting is largelyconcerned with assigning the value of pasttransactions to appropriate timeperiods."[Footnote 12]

[Footnote 12: Statement of Federal Financial


Accounting Concepts No.1, "Objectives of FederalFinancial Reporting," par. 168, page 55.]

Relationship to Budgetary Accounting

49. Managerial cost accounting should alsoprovide budgetary accounting with costinformation. However, the two are not as closelyaligned as is the case with financial accounting(see Figure 1). Mostly, this is because costs areusually recorded, accumulated, and allocated bymanagerial cost accounting on an accrual basis ofaccounting which is different from the obligationor cash basis generally used in budgetaryaccounting.

50. Still, managerial cost accounting doesprovide cost information to budgetary accountingfor use in preparing yearly and long-term budgetsfor required materials, supplies, equipment, humanresources, and other resources needed to producedifferent levels of outputs. Managerial costaccounting also helps in making many budgetarydecisions such as those concerning future capitalexpenditures and purchase/lease alternatives.

51. It is important to note that the Board'sauthority does not extend to recommendingbudgetary standards or budgetary concepts, andthat is not the purpose of thisstatement.[Footnote 13] However, the Board iscommitted to providing relevant and reliable costaccounting information that supports budgetplanning, formulation, and execution.

[Footnote 13: Memorandum of Understanding establishingthe FASAB, October 10, 1990.]

Cost Information for Management Purposes

52. Managerial cost accounting producesinformation directly for management use, sometimesemploying data produced by the budgetary andfinancial accounting processes. Cost informationis used for many different purposes which can begenerally classified into five types: performance


measurement; cost reduction and control;determination of reimbursements and fee or pricesetting; program authorization, modification, anddiscontinuation decisions; and decisions tocontract out work or make other changes in themethods of production.

53. To meet these needs, managerial costaccounting should use basic cost data and non-financial or programmatic data. For example, ittracks units of output produced and input usedincluding the amount of labor in terms ofemployees or employee-hours. Sometimes,information from cost analysis is used to compareactual to predetermined or anticipated costs. Anorganization may use cost estimates, cost studies,and cost finding techniques.

54. While managerial cost accounting is concernednot only with past costs and future costs, one ofits most important features is the use of presentcosts to assist management. This current costaspect of managerial cost accounting is referredto in the Objectives of Federal FinancialReporting where is states that "accounting datamay be further assigned, allocated, or associatedwith units of activity or production, segments oforganizations, etc., within the same time period.These kinds of intraperiod allocations aredeveloped most extensively in the branch ofaccounting called cost accounting. Neither theFASB nor the GASB has devoted much attention tothis branch of accounting, but the FASAB, becauseof its unique mission, will need to doso."[Footnote 14] Managerial cost accountinginformation pertaining to present costs is mostoften used for controlling and reducing thosecosts, controlling work processes, and measuringcurrent performance.

[Footnote 14: Statement of Federal FinancialAccounting Concepts No. 1, "Objectives of FederalFinancial Reporting," par. 174, page 56.]

Reporting Relationships


55. Proper financial management requires that thethree accounting processes work closely togetherto provide useful reporting to both internal andexternal users. The internal-external dual focusof federal reporting has been established in theObjectives of Federal Financial Reporting. Itstates that "The FASAB and its sponsors believethat any description of federal financialreporting objectives should consider the needs ofboth internal and external users and the decisionsthey make." In addition, it says that "theFASAB...considers the information needs of bothinternal and external users. In part, this isbecause the distinction between internal andexternal users is in many ways less significantfor the federal government than for otherentities." It goes on to classify the users offinancial information into four major groups:program managers, executives, the Congress, andcitizens.[Footnote 15] These categories includeboth internal and external users.

[Footnote 15: Ibid., pars. 23, 25, page 9; and par.75, page 26.]

56. Federal financial reporting encompassesgeneral and special purpose reports to meet theneeds of the four user groups. Informationproduced by managerial cost accounting appears inor influences both types of reports.[Footnote 16]As discussed above, managerial cost accountingshould provide information for use by bothfinancial accounting and budgetary accounting.That information is used by those processes inproducing both general purpose and special purposereports.

[Footnote 16: The types of general purpose and specialpurpose reports are discussed in Statement of FederalFinancial Accounting Concepts No.1, "Objectives ofFederal Financial Reporting," Chapter 7.]

57. Managerial cost accounting also results inreports of its own. Most often these are specialpurpose reports designed for internal users,typically program and line managers. However,


they may be for groups generally consideredexternal users.

58. One of the most important aspects ofreporting in which managerial cost accountingplays a large role is that of performancereporting. Measuring and reporting actualperformance against established goals is essentialto assess governmental accountability. Costinformation is necessary in establishing strategicgoals, measuring service efforts andaccomplishments, and relating efforts toaccomplishments. The importance of costinformation in relation to performance measurementand performance reporting has been recognized inthe Objectives of Federal Financial Reporting,which said "One reason for performing costaccounting is to assist in performancemeasurement" and it also stated that "The topicsof cost and performance measurement are relatedbecause it is by associating cost with activitiesor 'cost objectives' that accounting can make muchof its contribution to reporting onperformance."[Footnote 17]

[Footnote 17: Ibid., par. 174, page 56; and par. 192,page 63.]

Basis of Accounting andRecognition/Measurement Methods

59. Costs may be measured, analyzed, and reportedin many ways. A particular cost measurement hasmeaning only when considering its purpose. Themeasurement of costs can vary depending upon thecircumstances and purpose for which themeasurement is to be used. In Objectives ofFederal Financial Reporting, it is stated that"the Board's own focus is on developing generallyaccepted accounting standards for reporting on thefinancial operations, financial position, andfinancial condition of the federal government andits component entities and other useful financialinformation. This implies a variety of measuresof costs and other information that complements


the information available in the budget [emphasisadded]."[Footnote 18]


60. In addition, it is stated that "In definingthe proper measurement, assignment, and allocationof cost for a given purpose, selecting theappropriate accounting method and whether to usefull costing should be carefullyconsidered."[Footnote 19] Further, it added that"The accrual basis of accounting generallyprovides a better matching of costs to theproduction of goods and services, but its use andapplication for any given purpose must becarefully evaluated."[Footnote 20]



61. Therefore, managerial cost accounting shouldprovide cost information using a basis ofaccounting and recognition/measurement standardsthat are appropriate for the intended use of theinformation. When managerial cost accounting isused to supply information for use by financialaccounting and financial reporting, thatinformation should be consistent with the basis ofaccounting and recognition/measurement standardsrequired by federal accounting principles.Traditionally this has meant the use of accrualaccounting and historical cost measurement,particularly in general purpose reports.

62. When managerial cost accounting is used tosupply information for the preparation and reviewof budgets, cost data should be consistent withthe basis of accounting andrecognition/measurement used in financialreporting, but may be adjusted to meet thebudgetary information needs.

63. Special purpose cost studies and analyses aresometimes performed for decision making. In thosestudies and analyses, management may need to


develop cost data beyond those currently reportedin general purpose financial reports. Forexample, in making planning decisions, managementmay develop replacement costs and capital costs.However, the basis and methods used should beappropriate for the circumstances and consistentwith the intended purposes.

Reconciliation of Information

64. Different bases of accounting will producedifferent costs for the same item, activity, orentity. This can confuse users of costinformation. Therefore, reports that usedifferent accounting bases or differentrecognition and measurement methods should bereconcilable, and should fully explain those basesand methods. Regardless of the type of report inwhich it is presented, cost information shouldultimately be traceable back to the originalcommon data source.

65. To be reconcilable, the amount of thedifferences in the information reported should beascertainable and the reasons for the differencesshould be explainable. In some situations,informational differences may be clearlyunderstandable without further explanation.However, other cases may require a narrativestatement concerning the differences. Incomplicated situations, a schedule or table may berequired to fully explain the differences.

66. Financial reporting has long recognized thenecessity for reconciliation between informationreported on different accounting bases.Reconciliations have been required in federalfinancial reports to show and explain significantdifferences between budget reports and financialstatements prepared in accordance with generallyaccepted accounting principles.

*******************************************************MANAGERIAL COST ACCOUNTING STANDARDS


REQUIREMENT FOR COST ACCOUNTING

Each reporting entity [Footnote 21] shouldaccumulate and report the cost of its activities on aregular basis for management information purposes.Costs may be accumulated either through the use of costaccounting systems or through the use of cost findingtechniques.

[Footnote 21: The term "reporting entity" as used inthis docoment conveys the same meaning as defined inFASAB Statement of Recommended Accouynting Concepts No.2, "Entity and Display" (May 1995).]

67. Cost information is essential to effectivefinancial management and should play an importantrole in federal financial reporting. Managerialcost accounting processes are the means ofproviding cost information in an efficient andreliable manner on a continuing basis.

Need for Consistent CostAccounting on a Regular Basis

68. To perform managerial cost accounting on a"regular basis" means that entities shouldestablish procedures to accumulate and reportcosts continuously, routinely, and consistentlyfor management information purposes. Consistentand regular cost accounting is needed to meet thesecond objective of federal financial reportingwhich states information should be provided tohelp the user determine the costs of providingspecific programs and activities and thecomposition of, and changes in those costs. Thatobjective also requires the reporting ofperformance information of federal programs andthe changes over time in that performance inrelation to the costs.

69. The requirement for managerial costaccounting on a regular and consistent basissupports recent legislative actions. The CFO Actof 1990 states that agency CFOs shall provide forthe development and reporting of cost information


and the periodic measurement of performance. Inaddition, the GPRA of 1993 requires each agency,for each program, to establish performanceindicators and measure or assess relevant outputs,service levels, and outcomes of each program as abasis for comparing actual results withestablished goals. The nature of theselegislative mandates requires reporting entitiesto develop and report cost information on aconsistent and regular basis.

70. The managerial cost accounting processesconsist of collecting data from the common datasource, processing that data, and reporting costand output information in general purpose andspecial purpose reports. Appropriate proceduresand practices should also be established to enablethe collection, measurement, accumulation,analysis, interpretation, and communication ofcost information. This can be accomplishedthrough the use of a cost accounting system or theuse of cost finding techniques and other coststudies and analyses. A cost accounting "system"is an organized grouping of methods and activitiesdesigned to consistently produce reliable costinformation.

Basic Cost Accounting Processes

71. Regardless of whether a reporting entity usesa cost accounting system or cost findingtechniques, the methods and procedures followedshould be designed to perform at least a certainminimum level of cost accounting and provide abasic amount of cost information necessary toaccomplish the many objectives associated withplanning, decision making, control, and reporting.The more important of these minimum criteria forcost accounting are associated with the standardsin the remainder of this statement. Others arealso important.

-- Responsibility Segments - Cost informationshould be collected by responsibilitysegments which have been identified bymanagement and outputs should be defined for


each responsibility segment.[Footnote 22]

[Footnote 22: See standard in this statementconcerning responsibility segments.]

-- Full Costing - Each reporting entity shouldmeasure the full cost of outputs so thattotal operational costs and total unit costsof outputs can be determined. "Full cost"includes the cost of goods or servicesprovided by other entities when theapplicable criteria are met.[Footnote 23]

[Footnote 23: See standard concerning full costs andstandard concerning inter-entity costing.]

-- Costing Methodology - The costing methodologyused (e.g., activity-based costing, job ordercosting, standard costing, etc.) should beappropriate for management's needs and theoperating environment.[Footnote 24]

[Footnote 24: See standard concerning costingmethodology.]

-- Performance Measurement - Cost accountingshould provide information needed todetermine and report service efforts andaccomplishments and information necessary tomeet the requirements of the GPRA orinterface with a system that provides suchinformation. This includes the quantity ofinputs and outputs and other non-financialinformation needed in the measurement ofperformance.

-- Reporting Frequency - Cost information shouldbe reported in a timely manner and on aregular basis consistent with the needs ofmanagement and the requirements of bothbudgetary and financial reporting.

-- Standard General Ledger - Managerial costaccounting should be integrated with generalfinancial accounting. Both depend on thestandard general ledger for basic financial


transaction data.

-- Precision of Information - Cost informationsupplied to internal and external usersshould be reliable and useful in makingevaluations or decisions. At the same time,unnecessary precision and refinement of datashould be avoided.

-- Special Situations - The managerial costaccounting processes should be designed toaccommodate any of management's special costinformation needs that may arise due tounusual or special situations orcircumstances. If such cost information isneeded on a regular basis, appropriateprocedures to provide it should be developed.

-- Documentation - All managerial costaccounting activities, processes, andprocedures should be documented by a manual,handbook, or guidebook of applicableaccounting operations. This reference shouldoutline the applicable activities, provideinstructions for procedures and practices tobe followed, list the cost accounts andsubsidiary accounts related to the standardgeneral ledger, and contain examples of formsand other documents used.

Complexity of Cost Accounting Processes

72. While each entity's managerial costaccounting should meet the basics discussed above,this standard does not specify the degree ofcomplexity or sophistication of any managerialcost accounting process. Each reporting entityshould determine the appropriate detail for itscost accounting processes and procedures based onseveral factors. These include the:

-- nature of the entity's operations;

-- precision desired and needed in costinformation;


-- practicality of data collection andprocessing;

-- availability of electronic data handlingfacilities;

-- cost of installing, operating, andmaintaining the cost accounting processes;and

-- any specific information needs of management.

73. Some entities may find that they can purchasebasic "off-the-shelf" cost accounting programs,systems, or processes, or adapt those of otherfederal agencies. All entities should considerusing similar or compatible cost accountingprocesses throughout their component units tofacilitate comparison and consolidation of costinformation.

Cost Findings, Studies, and Analyses

74. A cost accounting system is a continuousand systematic cost accounting process which maybe designed to accumulate and assign costs to avariety of objects routinely or as desired by themanagement. Such a system may be best for somereporting entities.

75. Some entities may not need a sophisticatedsystem to perform detailed cost accumulation andassignment. They need to accumulate and reportcosts regularly as required by this standard, butthey may determine and analyze costs throughspecial cost studies and analyses. Also, someentities may use a combination of a systemsupplemented by cost studies.

76. Cost information may be developed and savingsachieved in some cases by the use of special coststudies or cost analyses to develop informationhelpful in certain decision making situations. Inaddition, cost finding techniques may be used todetermine the cost of products or services. Costfinding is a method for determining the cost of


producing goods or services using appropriateprocedures. Cost finding techniques may also beuseful for computing costs in cases where theinformation is not needed on a recurring basis.

RESPONSIBILITY SEGMENTS

Management of each reporting entity should defineand establish responsibility segments. Managerial costaccounting should be performed to measure and reportthe costs of each segment's outputs. Special coststudies, if necessary, should also be performed todetermine the costs of outputs.

77. The standard states that the management ofeach reporting entity should define and establishresponsibility segments. This section explainsthe concept of responsibility segment, purposes ofsegmentation, and how responsibility segments canbe structured.

Defining Responsibility Segments

78. A responsibility segment is a component of areporting entity[Footnote 25] that is responsiblefor carrying out a mission, conducting a majorline of activity, or producing one or a group ofrelated products or services. In addition,responsibility segments usually possess thefollowing characteristics:

[Footnote 25: The term "reporting entity" referred toin this document conveys the same meaning as defined inFASAB Statement of Recommended Accounting Concepts No.2 Entity and Display (May 1995).]

(1) Their managers report to the entity's top management directly;

(2) Their resources and results of operations can be clearly distinguished from those of other segments of the


entity.[Footnote 26]

[Footnote 26: These two characteristics makeresponsibility segments, as the term is used in thisdocument, differ from cost centers. A cost center canbe at any level of an organization and may not reportto the top management directly. As will be explainedlater, a responsibility segment can contain costcenters in itself.]

79. A responsibility segment is a unit forwhich managerial cost accounting is performed.Entities may use a centralized accounting systemor segment-based systems to provide costinformation for each segment. For each segment,managerial cost accounting should:

(1) Define and accumulate outputs, and if feasible, quantify each type of output in units;

(2) Accumulate costs and quantitative units of resources consumed in producing the outputs; and

(3) Assign costs to outputs, and calculate the cost per unit of each type of output.

80. Some reporting entities may have only oneresponsibility segment, if they perform one singlemission or one type of service. Other reportingentities may have several responsibility segments.Also, a sub-organization of the federal governmentmay be a reporting entity in itself and, at thesame time, it may also be a responsibility segmentof a higher level reporting entity to which itbelongs. The Forest Service, for example, may bea reporting entity because it may meet thereporting entity criteria. As such, it mayestablish responsibility segments for itself. Atthe same time, the Forest Service may be regardedas a responsibility segment of the Department ofAgriculture, of which it is a component.

81. However, for a given reporting entity, its


management should establish one or moreresponsibility segments to perform managerial costaccounting functions.

Purposes of Segmentation

82. A basic purpose of dividing an entity intosegments is to determine and report the costs ofservices and products that each segment producesand delivers. Many federal departments andagencies manage programs that produce a variety ofgoods and services. Accounting for entity-widerevenues and expenses in aggregate would servefinancial reporting for the entity, but would notserve costing purposes. In order to determinethe cost of each type of service or product, it isnecessary to divide an entity into segments suchthat each segment is responsible for certain typesof services or products. Each segment can then beused as a vehicle for accumulating costs incurredby the segment to match with its outputs. Eachsegment can use a cost methodology that is bestsuited to its operations.

83. Another important purpose of segmentation isto facilitate cost control and management. Costinformation provided for each segment helpsmanagers to examine costs of specific resourcesconsumed and activities performed in each segment.Managers can analyze cost variances in bothdollars and the units of resources consumedagainst budgets or standards. Since each segmentperforms a particular pattern of processes andactivities to produce its output, managers cananalyze those processes and activities to comparetheir costs with the value they contribute to theoutput.

84. For entities that consist of componentsengaging in diverse lines of activities, it isdesirable to provide financial reports thatdisplay information for significant componentsindividually and of the entity in itsentirety.[Footnote 27] Some entities may findcosts accumulated by segments useful in support offinancial reporting by components.


[Footnote 27: This point is discussed in FASABStatement of Recommended Accounting Concepts No. 2,"Entity and Display," pars. 75-76, pages 25-26.]

85. For internal management, segmentation couldalso facilitate performance measurement. Sinceeach segment is responsible for a mission, or aline of activity to produce a certain type ofoutput, performance goals can be set for eachsegment based on its specific tasks and operatingpatterns. Information on costs, outputs, andoutcomes related to each segment can be used tomeasure its performance against the goals. Theresults of the segment performance measurementcould also support external reporting onperformance measures for the entire reportingentity or its major programs.

Structuring Responsibility Segments

86. Reporting entity management should defineand structure its responsibility segments. Thedesignation of responsibility segments should bebased on the following factors: (a) the entity'sorganization structure, (b) its lines ofresponsibilities and missions, (c) its outputs(goods or services it delivers), and (d) budgetaccounts and funding authorities. However, thepredominant factor is the reporting entity'sorganization structure and its existingresponsibility components, such as bureaus,administrations, offices, and divisions within adepartment.

87. The U.S. General Services Administration, forexample, provides five distinct services: (1)managing public buildings, (2) distributingsupplies, (3) providing travel and transportationservices, (4) managing information resources(including communication and data processingservices), and (5) disposal of real properties.Each of those service areas could be designated asa responsibility segment. The Department ofVeterans Affairs (VA), among its other services,provides health care to veterans, pays veterans'


compensation and pension benefits, and provideshome loans and home loan guarantees to veterans.Each of these program areas could constitute aresponsibility segment.

88. Since responsibility segments are major partsof an entity, some segments may carry more thanone program. Some programs may be jointly managedby two or more segments. Thus, each segment mustaccumulate costs for each type of output producedfor various programs. To accomplish this, anetwork of cost centers can be established withina segment to accumulate costs. Managers of eachcost center will be provided with information tocontrol and manage costs within their area ofresponsibility. Depending on operational patternsand cost methods, cost centers can be structuredalong different dimensions, such as organizationalunits, operating processes, and activities.

FULL COST

Reporting entities should report the full costs ofoutputs in general purpose financial reports. The fullcost of an output produced by a responsibility segmentis the sum of (1) the costs of resources consumed bythe segment that directly or indirectly contribute tothe output, and (2) the costs of identifiablesupporting services provided by other responsibilitysegments within the reporting entity, and by otherreporting entities.

89. This standard states that reporting entitiesshould measure and report the full costs of theiroutputs in general purpose financial reports."Outputs" means products and services generatedfrom the consumption of resources. The full costof a responsibility segment's output is the totalamount of resources used to produce the output.This includes direct and indirect costs thatcontribute to the output, regardless of fundingsources. It also includes costs of supportingservices provided by other responsibility segments


or entities. The standard does not require fullcost reporting in federal entities' internalreports or special purpose cost studies. Entitymanagement can decide on a case-by-case basiswhether full cost is appropriate and should beused for internal reporting and special purposecost studies.

Direct Costs

90. Direct costs are costs that can bespecifically identified with an output. Alldirect costs should be included in the full costof outputs. Typical direct costs in theproduction of an output include:

(a) Salaries and other benefits for employees who work directly on the output;

(b) Materials and supplies used in the work;

(c) Various costs associated with office space, equipment, facilities, and utilities that are used exclusively to produce the output; and

(d) Costs of goods or services received from other segments or entities that are used to produce the output (See discussions and explanations in the next section on "Inter-Entity Costs").

Indirect Costs

91. Indirect costs are costs of resources thatare jointly or commonly used to produce two ormore types of outputs but are not specificallyidentifiable with any of the outputs. Typicalexamples of indirect costs include costs ofgeneral administrative services, general researchand technical support, security, rent, employeehealth and recreation facilities, and operatingand maintenance costs for buildings, equipment,and utilities. There are two levels of indirect


costs:

(a) Indirect costs incurred within a responsibility segment. These indirect costs should be assigned to outputs on a cause-and- effect basis, if such an assignment is economically feasible, or through reasonable allocations. (See discussions on cost assignments in the "Costing Methodology" section.)

(b) Costs of support services that a responsibility segment receives from other segments or entities. The support costs should be first directly traced or assigned to various segments that receive the support services. They should then be assigned to outputs.

92. A reporting entity and its responsibility segments may incur general management and administrative support costs that cannot be traced, assigned, or allocated to segments and their outputs. These unassigned costs are part of the organization costs, and they should be reported on the entity's financial statements (such as the Statement of Net Costs) as costs not assigned to programs.[Footnote 28]

[Footnote 28: A similar explanation is provided inFASAB Statement of Recommended Accounting Concepts No.2, Entity and Display, par. 95, page 33.]

Certain Cost Elements

93. Costs of Employees' Benefits

Employee benefits include:

(a) Health and life insurance benefits for current employees covered in part by the government's contribution to health and life insurance premiums;

(b) Pension benefits for employees, their survivors, and dependents, covered by defined


pension plans such as Civil Service Retirement System (CSRS), Federal Employees Retirement Plan (FERS), and Military Retirement System (MRS);

(c) Health and life insurance benefits for retired employees, their survivors and dependents, covered in part by the government's contribution to health and life insurance premiums, and referred to as "other retirement benefits" (ORB) in this document;

(d) Other postemployment benefits (OPEB) for terminated and inactive employees, which include severance payments, training and counseling, continued health care, and unemployment and workers compensation.

94. Most of the employee benefit programs arecovered by trust funds administered by the Officeof Personnel Management (OPM) and the Departmentof Defense (DoD). Contributions to the trustfunds come from three sources: current and retiredemployees, employing agencies, and directappropriations. The management expenses of thetrust funds are paid with the funds' receipts.

95. Federal financial accounting standardsrequire that the employing entity accrue the coststo the federal government of providing pension andORB benefits to employees and recognize the costsas an expense when the benefits areearned.[Footnote 29] The employing entity shouldrecognize those expenses regardless of whether thebenefits are funded by the reporting entity or bydirect appropriations to the trust funds. Thisprinciple should also be applied to health andlife insurance benefits for current employees andcomparable benefits for military personnel. Thecosts of employee benefits incurred byresponsibility segments should be directly tracedor assigned to outputs.

[Footnote 29: FASAB Exposure Draft, "Accounting forLiabilities of the Federal Government" (November 7,1994), pars. 62-99, pages 26-46.]


96. OPEB costs include severance payments,counseling and training, health care, and workerscompensation benefits paid to former or inactiveemployees. OPEB costs are often incurred as aresult of such events as reductions in force oron-the-job injuries of employees. Federalfinancial accounting standards require that OPEBcosts be reported as an expense for the periodduring which a future outflow or other sacrificeof resources is probable and measurable on thebasis of events occurring on or before theaccounting date.[Footnote 30]

[Footnote 30: Ibid., pars. 100-102, page 47.]

97. Since the recognition of OPEB costs is linkedto the occurrence of an OPEB event rather then theproduction of output, in many instances, assigningOPEB costs recognized for a period to output ofthat period would distort the cost of output. Inspecial purpose cost studies or cost findings,management may distribute OPEB costs over a numberof years in the past to determine the costs of theoutputs that the OPEB recipients helped toproduce.

Costs of Public Assistance and Social InsurancePrograms

98. Major costs of welfare, insurance, and grantprograms are the costs of resources transferredfrom the federal government to individuals andstate and local governments. Some of them arereferred to as "transfer payments." The followingare some typical public assistance and insuranceprograms:

-- Grants, such as aid to state and localgovernments;

-- Subsidies, such as agricultural commodityprice support and stabilization programs;

-- Credit and insurance costs, such as theFamily Education Loan Program and Savings


Association Insurance;

-- Welfare payments such as Aid to Families withDependent Children (AFDC); and,

-- Social insurance, such as the Old Age,Survivors, and Disability InsuranceProgram.

99. The full cost of such a program includes: (a)the costs of federal resources that have been orwill be transferred to individuals and state/localgovernments, and (b) the costs of operating theprograms. These two types of costs should berecognized on a basis of accounting that isprescribed within the Federal Financial AccountingStandards. These two types of costs should beseparately identified so that each can be used fordifferent analytic purposes.

100. The costs resulting from transfer paymentsare determined by the level of grants, subsidies,entitlement benefits, credit subsidies, or losspayments made under insurance and guaranteeagreements. They are also determined by thenumber of eligible persons who receive thetransfer payments. The program cost of AFDC, forexample, depends on the average payment perfamily, the number of eligible families, and thefederal government's share in the payments (somepayments are made by state and local governments).Information on this type of cost is useful formaking policy decisions about levels of subsidiesor benefits, eligibility of recipients, and howtransfer payments are made. This cost informationis also useful for measuring the cost-effectiveness of a transfer payment program.

101. Program operating costs, on the other hand,are costs of managing the program and deliveringthe payments. They include the costs ofpersonnel, supplies, equipment, and offices. Thecosts are related to such activities as screeningbenefit recipients for eligibility, keeping theiraccounts, making payments and collections,answering inquiries, etc. Information on this


type of cost is useful in measuring the efficiencyof program operations.

Costs related to Property, Plant and Equipment

102. Depreciation expense. General property,plant, and equipment are used in the production ofgoods and services. Their consumption isrecognized as depreciation expense. Thedepreciation expense incurred by responsibilitysegments should be included in the full costs ofthe goods and services that the segments produce.

103. Recognizing property acquisition costs asexpenses. The costs of acquiring or constructingfederal mission and heritage property, plant, andequipment may be charged to expenses at the timethe acquisition costs are incurred.[Footnote 31]Since the recognition of these expenses is linkedto property acquisition rather than production ofgoods and services, those expenses should not beincluded in the full costs of goods and services.However, they are part of the costs of the entityor the program that makes the propertyacquisitions.

[Footnote 31: In FASAB Exposure Draft, "Accounting forProperty, Plant, and Equipment," the Board proposedthat the costs of acquiring or constructing "federalmission" and "heritage" property, plant, and equipmentbe recognized as expenses when the costs are incurred.See the ED, pars. 98-117, pages 29-34.]

Non-production costs

104. A responsibility segment may incur andrecognize costs that are linked to events otherthan the production of goods and services. Twoexamples of these non-production costs werediscussed earlier: (1) OPEB costs that arerecognized as expenses when an OPEB event occurs,and (2) certain property acquisition costs thatare recognized as expenses at the time ofacquisition. Other non-production costs includereorganization costs, and nonrecurring cleanupcosts resulting from facility abandonments that


are not accrued. Since these costs are recognizedfor a period in which a particular event occurs,assigning these costs to goods and serviceproduced in that period would distort theproduction costs. In special purpose coststudies, management may have reasons to determinehistorical output costs by distributing some ofthese costs to outputs over a number of pastperiods. Such distribution may be appropriatewhen: (a) experience shows that the costs arerecurring in a regular pattern, and (b) a nexuscan be established between the costs and theproduction of outputs that may have benefited fromthose costs.

INTER-ENTITY COSTS

Each entity's full cost should incorporate thefull cost of goods and services that it receives fromother entities. The entity providing the goods orservices has the responsibility to provide thereceiving entity with information on the full cost ofsuch goods or services either through billing or otheradvice.

Recognition of inter-entity costs that are notfully reimbursed is limited to material items that (1)are significant to the receiving entity, (2) form anintegral or necessary part of the receiving entity'soutput, and (3) can be identified or matched to thereceiving entity with reasonable precision. Broad andgeneral support services provided by an entity to allor most other entities should not be recognized unlesssuch services form a vital and integral part of theoperations or output of the receiving entity.

105. As stated in the preceding standard, to fullyaccount for the costs of the goods and servicesthey produce, reporting entities should includethe cost of goods and services received from otherentities. Knowledge of these costs is helpful totop level management in controlling and assessingthe operating environment. It is also helpful to


other users in evaluating overall program costsand performance and in making decisions aboutresource allocations and changes in programs.

Inter-Entity Activities

106. Within the federal government, some reportingentities rely on other federal entities to helpthem achieve their missions. Often this involvessupport services, but may include the provision ofgoods. Sometimes these arrangements may bestipulated by law, but others are established bymutual agreement of the entities involved. Suchrelationships can be classified into two typesdepending upon funding methods.

-- Provision of goods or services withreimbursement -- In this situation, oneentity agrees to provide goods orservices to another with reimbursementat an agreed-upon price. Thereimbursement price may or may not beenough to recover full costs. Usuallythe agreement is voluntarily establishedthrough an inter-agency agreement.Revolving funds can also be included inthis group, because they are usuallyestablished to recover costs throughsale of their outputs to othergovernment entities. They are usuallymeant to be self-sustaining throughtheir sales, without receivingadditional appropriations. However,

they do not always charge enough tocover full costs.

-- Provision of goods or services withoutreimbursement -- One entity providesgoods or services to another entity freeof charge. The agreement may bevoluntary, legally mandated, orinherently established in the mission ofthe providing entity.

107. Recently, consideration has been given to


expanding the concept of inter-entity supportwithin the federal government. Under thisconcept, entities could sell their outputs on acompetitive basis. Entities would have theauthority to purchase goods or services from anyfederal or private provider. This is seen as away to improve government efficiency throughcompetition since inefficient government providerswould be forced to improve or stop providing thesegoods or services. This could result inconsolidating support services in fewergovernmental entities. Underlying this concept isthe requirement that all costs be recognized indeveloping the price at which goods and serviceswould be sold to other entities.

Accounting and Implementation Guidance

108. If an entity provides goods or services toanother entity, regardless of whether fullreimbursement is received, the providing entityshould continue to recognize in its accountingrecords the full cost of those goods or services.The full costs of the goods or services providedshould also be reported to the receiving entity bythe providing entity.

109. The receiving entity should recognize in itsaccounting records the full cost of the goods orservices it receives as an expense or, ifappropriate, as an asset (such as work-in-processinventory). The information on costs of non-reimbursed or under-reimbursed goods or servicesshould be available from the providing entity.However, if such cost information is not provided,or is partially provided, a reasonable estimatemay be used by the receiving entity. The estimateshould be of the cost of the goods or servicesreceived (the estimate may be based on the marketvalue of the goods or services received if anestimate of the cost cannot be made). To theextent that reimbursement is less than full cost,the receiving entity should recognize thedifference in its accounting records as a


financing source.[Footnote 32] Inter-entityexpenses/assets and financing sources would beeliminated for any consolidated financialstatements covering both entities.

[Footnote 32: See Statement of Recommended FederalAccounting Concepts No. 2, Entity and Display, par. 65,page 21. See also, FASAB Exposure Draft, Accountingfor Liabilities of the Federal Government, pars. 62-99,pages 26-46, which addresses accounting for pensionsand other retirement benefits (ORB). The payment ofpension and ORB costs for an entity by another entityhas often been likened to providing goods and services.

In the case of pensions, employees of the reportingentity provide services to that entity and part of thesalary-related cost is paid by a different entity. Thepension administering entity does not provide goods orservices to the reporting entity (other than normalpension administration services), but rather pays theircosts directly. The difference is subtle butimportant. However, the accounting is similar. Thisdocument is consistent with the section of theliabilities exposure draft dealing with accounting forpensions and other retirement benefits.]

110. Implementation of this standard on inter-entity costing should be accomplished in apractical and consistent manner by the variousfederal entities. Therefore, the Office ofManagement and Budget, with assistance from theFASAB staff, should identify the specific inter-entity costs for entities to begin recognizing.OMB should then issue guidance identifying thesecosts. These particular inter-entity costs shouldbe specified in accordance with this standardincluding the recognition criteria presentedbelow. The OMB should consider information andadvice from Treasury, GAO, and other agencies indeveloping the implementation guidance. It isanticipated that the largest and most importantinter-entity costs will be identified first. Asentities gain experience in the application of thestandard, recognition of other inter-entity costsmay be specified in future guidance or required byfuture standards.


Recognition Criteria

111. Ideally, all inter-entity costs should berecognized. This is especially important whenthose costs constitute inputs to government goodsor services provided to non-federal entities for afee or user charge. The fees and user chargesshould recover the full costs of those goods andservices.[Footnote 33] Thus, the cost of inter-entity goods or services needs to be recognized bythe receiving entity in order to determine fees oruser charges for goods and services sold outsidethe federal government. Such recognition,however, should be made in accordance with theimplementation guidance issued by OMB as discussedabove.

[Footnote 33: OMB Circular A-25 addresses user chargesby federal entities.]

112. However, the situation is often differentwith goods or services transferred within thefederal government that do not involve eventualsales to entities outside the federal government.The federal government in its entirety is aneconomic entity. Therefore, it is reasonable toexpect some flow of goods or services betweenreporting entities as those entities assist eachother in fulfilling their missions and operatingobjectives. There are some cases in which thecost of non-reimbursed or under-reimbursed goodsor services received from other entities need notbe recognized as part of the cost of the receivingentity. The following general criteria areprovided to help in determining the types of --inter-entity costs that should or should not berecognized.

-- Materiality -- As with other accountingstandards, the provisions of this standardneed not be applied to immaterial items.However, in the context of deciding whichinter-entity transactions are to berecognized, materiality, as used here, isdirected to the individual inter-entity


transaction rather than to all inter-entitytransactions as a whole. Under this concept,a much more limited recognition is intendedthan would be achieved by reference to thegeneral materiality concept.

In this context, then, materiality should beconsidered in terms of the importance of theinter-entity transaction to the receivingentity. The importance of the transactions,and thereby their recognition, should be judgedin light of the following factors:

* Significance to the entity -- The cost of thegood or service is large enough thatmanagement should be aware of the cost whenmaking decisions.

* Directness of relationship to the entity'soperations -- The good or service provided isan integral part of and necessary to theoutput produced by the entity.

* Identifiability -- The cost of the good orservice provided to the entity can be matchedto the entity with reasonable precision.

The determination of whether the cost ismaterial requires the exercise of considerablejudgment, based on the specific facts andcircumstances of each transaction.

-- Broad, general support -- Some entitiesprovide broad, general support to many, ifnot all, reporting entities in the federalgovernment. Most often this type of supportinvolves the establishment of policies and/orthe provision of general guidance. The costsof such broad services should not berecognized as an expense (or asset) by thereceiving entities when there is noreimbursement of costs. Thus the standarddoes not apply when support is of a generalnature provided to all or most entities ofthe federal government.


An example of this situation can be found inthe Office of Management and Budget whichestablishes policy and provides generalguidance to all parts of the executive branchof government. The costs of OMB should not bespread over all reporting entities because theservices provided are (1) general and broad inscope, (2) provided to almost all reportingentities in the executive branch, and (3) notspecifically or directly tied to the receivingentity's outputs.

On the other hand, some services provided,under certain circumstances, should still berecognized even though they may be consideredbroad and general in nature if such servicesare integral to the operations of the receivingentity. Such services include check writing bythe Department of Treasury or legal activitiesperformed by the Department of Justice. Forexample, when the issuance of checks isintegral to the operations of an entity (e.g.,the Internal Revenue Service and the SocialSecurity Administration), the receiving entityshould include the full cost of issuing checksin the full cost of its outputs. However, ifthe issuance of checks is insignificant andincidental to the operations of an entity, theentity should not normally recognize that cost.

113. The decision as to whether the cost of non-reimbursed or under-reimbursed goods and servicesshould be recognized requires the use ofjudgement. None of the criteria listed above are,by themselves, fully or exclusively determinative.They should be considered in combination.Ultimately, inclusion or exclusion of the costshould be decided based on the specific facts andcircumstances of each case, with consideration ofthe degree to which inclusion or exclusion wouldchange or influence the actions and decisions of areasonable person relying on the informationprovided.

Accounting Example


114. The following tables provide an example ofthe accounting entries to be made when thereceiving entity (Agency R) recognizes an expensefor services received from a providing entity(Agency P) on a non-reimbursable basis. In theexample, the full costs of these services toAgency P are $100,000.

115. Agency R recognizes an "Expense of servicesprovided by Agency P" equal to the full cost ofthe services received. It also recognizes afinancing source, "Services provided by Agency P,"equal to the amount not reimbursed, which in thiscase is the full $100,000. Agency P recognizes an"Expense of services provided to Agency R" equalto the full cost of the services provided with acredit to "Appropriations used."

Table 1: Agency R's Accounting Entries *

Debit Credit

Expense of services provided by Agency P: $100,000

Services provided by Agency P: $100,000

* This example shows the cost recognized as an expense.However, as discussed in the text, it may be an asset.

Table 2: Agency P's Accounting Entries

Debit Credit

Expense of services provided to Agency R: $100,000Appropriated capital $100,000

Fund balance with Treasury $100,000Appropriated capital used $100,000


COSTING METHODOLOGY

Costs of resources consumed by responsibilitysegments should be accumulated by type of resource.Outputs produced by responsibility segments should beaccumulated and, if practicable, measured in units.The full costs of resources that directly or indirectlycontribute to the production of outputs should beassigned to outputs through costing methodologies orcost finding techniques that are most appropriate tothe segment's operating environment and should befollowed consistently.

The cost assignments should be performed by thefollowing methods listed in the order of preference:(a) directly tracing costs wherever feasible andeconomically practicable, (b) assigning costs on acause-and-effect basis, or (c) allocating costs on areasonable and consistent basis.

116. This standard addresses two aspects ofcosting: cost accumulation and cost assignment.Each of them is explained and discussed below.

Cost Accumulation

117. Cost accumulation is the process ofcollecting cost data in an organized way. Thestandard requires that costs be accumulated byresponsibility segments. The accumulation is forcosts incurred within each responsibility segment,and does not involve the assignment or allocationof costs incurred by other supporting segments,which will be discussed in the latter part of thissection.

118. In the section of this document relating to"Responsibility segments," it was explained that:"A responsibility segment is a component of areporting entity, that is responsible for carryingout a mission, conducting a major line of


activity, or producing one or a group of relatedproducts or services." The accumulation of costsby responsibility segments does not mean that eachresponsibility segment must have its ownaccounting system. The reporting entity may havea centralized accounting system, but the systemshould be capable of identifying costs withresponsibility segments.

119. This standard also requires that theaccumulated costs be classified by type ofresource, such as costs of employees, materials,capital, utilities, rent, etc. When appropriateand cost effective, information on quantitativeunits related to various cost categories should bemaintained. For example, staff-days may bereported for staff salaries and benefits, andgallons of gasoline consumed for gasoline costs.The quantitative units are useful for costassignments, and are indispensable for measuringefficiency in using resources.

Cost Assignment

120. The term "cost assignment" refers to theprocess that identifies accumulated costs withreporting periods and cost objects. Theassignment of costs to time periods is torecognize costs either as expenses or assets foreach reporting period. It is governed byaccounting standards on recognition of assets andexpenses, and will not be addressed in thisdocument. This section addresses cost assignmentto cost objects. The word "assignment" used inthis document includes various methods ofattributing costs, such as direct tracing, cause-and-effect basis, and cost allocations.

121. The term "cost object" refers to an activityor item whose cost is to be measured.[Footnote 34]In a broad sense, a cost object can be anorganizational division, program, activity, task,product, service, or customer. However, thepurpose of cost accounting by a responsibilitysegment is to measure the costs of its outputs.Thus, the final cost objects of a responsibility


segment are its outputs: the services or productsthat the segment produces and delivers, themissions or tasks that the segment performs, orthe customers or markets that the responsibilitysegment serves. There may be intermediate costobjects that are used in the course of the costassignment process.

[Footnote 34: Some literature, the CASB pronouncementsfor example, use the term "cost objective" for the samemeaning.]

122. Some responsibility segments of an entity mayprovide supporting services or deliverintermediate products to other segments within thesame entity. The costs of the supporting servicesand intermediate products should be assigned tothe segments that receive the services andproducts. This is referred to as the intra-entitycost assignments. Also, in accordance with theinter-entity cost standard discussed in thepreceding section, an entity should recognizeinter-entity costs for goods and services receivedfrom other federal entities. The inter-entitycosts should also be assigned to theresponsibility segments that use the inter-entityservices and products.

123. Thus, with respect to each responsibilitysegment, the costs that are to be assigned tooutputs include: (a) direct and indirect costsincurred within the responsibility segment, (b)costs of other responsibility segments that areassigned to the segment, and (c) inter-entitycosts recognized by the receiving entity andassigned to the segment. If a responsibilitysegment produces one kind of output only, costs ofresources used to produce the output are assignedto the output.

124. This standard is intended to establish aprinciple, rather than a methodology, for costassignment. Also cost assignments may beperformed in cost findings and studies or may beperformed within a system on a regular basis. Inprinciple, costs should be assigned to outputs in


one of the methods listed below in the order ofpreference:

(a) Directly tracing costs wherever economically feasible;

(b) Assigning costs on a cause-and-effect basis; and

(c) Allocating costs on a reasonable and consistent basis.

125. These principles apply to all levels of costassignments including: (1) assigning inter-entitycosts to segments, (2) assigning the costs ofsupport services and intermediate products amongsegments of an entity (the intra-entity costassignments), and (3) assigning direct andindirect costs to outputs.

Directly tracing costs to outputs

126. Direct tracing applies to resources that aredirectly used in the production of an output.Examples of such resources include materials thatare used in the production, employees who directlyworked on the output, facilities and equipmentused exclusively in the production of the output,and goods or services received from other entitiesthat are directly used in the production of theoutput.

127. The method of direct cost tracing usuallyrelies on the observation, counting, and/orrecording of the consumption of resource units,such as staff hours or days that are spent on aproject or assignment, or gallons of fuel consumedin a transport mission. Direct tracing alsoapplies to specific resources that are dedicatedto particular outputs.

128. Direct cost tracing often minimizesdistortion and ensures accuracy in costassignments. However, it can be a relativelycostly process. It should be applied only toitems that account for a substantial portion of


the cost of an output and only when it iseconomically feasible. For example, it is usuallyunnecessary to trace the cost of office supplies(pens, papers, computer disks, etc.) to variousactivities or outputs. The cost of so doingusually outweighs the benefit of the increasedaccuracy in assigning the resources.

Assigning costs on a cause-and-effect basis

129. For the costs that are not directly traced tooutputs, it is preferable that they be assigned tothem on a cause-and-effect basis. As mentionedearlier, the ultimate cost objects of aresponsibility segment are its outputs. For coststhat are not traced to the ultimate objects(outputs), intermediate objects can be establishedas links between resource costs and outputs. Thelinks reflect a cause-and-effect relationshipbetween resource costs and outputs. Costs thathave a similar cause-and-effect relationship tooutputs can be grouped into cost pools. (Thissimilar relationship is referred to in someliterature as the "cost pool homogeneityconcept.")

130. Activities or work elements that contributeto or support the production of outputs arecommonly used as intermediate objects. This isbased on the premise that on one hand, outputsrequire the performance of certain activities, andon the other hand the activities cause costs.Thus, an activity is considered a linkage betweenthe cause and the effect. (See also, discussionson Activity-Based Costing later in this section.)In its policy statement, the Cost AccountingStandards Board expressed a similar view:

"The preferred presentation of the relationship between the pooled cost and the benefiting cost objectives is a measure of the activity (input) of the function or functions represented by the pool of cost. This relationship can be measured in


circumstances where there is direct and definitive relationship between the function or functions and the benefiting cost objectives."[Footnote 35]

[Footnote 35: Cost Accounting Standards Board,Restatement of Objectives, Policies and Concepts, par.2915.]

131. For example, a computer technology departmentprovides technical support to other departments ofan organization. The costs of the department maybe assigned to other departments on a cause-and-effect basis through two steps. In the firststep, the costs are assigned to the activities ofthe department, such as hardware installation andmaintenance, software design and installation, orprogramming adjustments. In the second step, thecosts of these activities are further assigned toother departments based on their consumption ofthe technical services.

132. Sometimes, an intermediate product, ratherthan an activity, can be used as a link betweenthe costs and outputs. For example, a hospitallaboratory's costs can first be assigned tovarious medical tests it runs. The costs of thetests can then be assigned to the operating unitsof the hospital that ordered the tests.

Allocating costs

133. Sometimes, it might not be economicallyfeasible to directly trace or assign costs on acause-and-effect basis. These may include generalmanagement and support costs, depreciation, rent,maintenance, security, and utilities associatedwith facilities that are commonly used by varioussegments.

134. These supporting costs can be allocated tosegments and outputs on a prorated basis. Thecost allocations may involve two steps. The firststep allocates the costs of support services tosegments, and the second step allocates thosecosts to the outputs of each segment. The cost


allocations are usually based on a relevant commondenominator such as the number of employees,square footage of office space, or the amount ofdirect costs incurred in segments.

135. Suppose the total cost of a personneldepartment for a fiscal year is $500,000, and itis allocated to two segments based on the numberof employees of the two segments: segment A has300 employees, and segment B has 200 employees.On the prorated basis, segment A should beallocated 60 percent, or $300,000 of the personnelcost, and segment B should be allocated 40percent, or $200,000 of the personnel departmentcost. The allocation is shown below:

Table 3: The Allocation of the Personnel Dept. Costs

Segment Employees Percent Allocated amountA 300 60 $300,000B 200 40 $200,000Total 500 100 $500,000

136. For cost allocation purposes, indirect costsmay be grouped into pools, and each pool issubject to one allocation base. Costs groupedinto one pool should have similar characteristics.The allocation base should be used consistently toallow cost comparison from one period to another.

137. Cost allocation is a relatively simple methodof assigning indirect costs to cost objects.Users of the cost information should be aware thatdistortions in product costing often result fromarbitrary cost allocations. In most cases, thereis little correlation between an indirect cost andthe allocation base, and the allocation isarbitrary. To assist cost analyses and costfindings, cost accounting should segregate coststhat are traced or assigned to outputs from coststhat are allocated to outputs.

Assigning common costs


138. Facility and personnel resources may beshared by two or more activities either at thesame time or in different times during a fiscalyear. For example, a military aircraft maintainedfor war readiness may be used in peacetime totransport cargo. As another example, a plant maybe used to process two or more products.

139. The cost assignment principles discussed inthis section should apply to assigning costs toactivities or outputs that share the use ofresources. Costs that can be traced to each ofthe activities (or outputs) should be assigned tothem directly. These include direct operatingcosts of each of the activities. For the militaryaircraft used in peacetime to transport cargo, forexample, the costs of fuel and supplies,additional personnel who worked on the cargo, andother costs incidental to the transportationshould be directly assigned to the transportationservices.

140. To determine the full cost of each of theactivities or outputs that share resources,indirect common costs should be assigned to thoseactivities. The term "common costs" refers to thecosts of maintaining and operating facilities andother resources that cannot be directly traced toany one of the activities or outputs that sharethe resources.[Footnote 36 Common costs should beassigned to activities either on a cause-and-effect basis, if feasible, or through reasonableallocations.

[Footnote 36: This definition is adapted fromStatement No. 1 on Management Accounting: ManagementAccounting Glossary, published by the NationalAssociation of Accountants (Montvale, New Jersey:1991), page 15.]

141. Sometimes management may find it useful todesignate primary and secondary activities thatshare resources. Primary activity is the primarypurpose or mission for which the resources aremade available. Secondary activities are those


activities that are performed only if they willnot interfere with the primary activity.Management can then determine two types of costs:(1) the costs that are necessary for the primaryactivity and are unavoidable even without thesecondary activities, and (2) the costs that arecaused by the secondary activities and areincremental to the costs of the primary activity.This type of cost information can be producedthrough cost findings, and may help management inmaking resource allocation and capacityutilization decisions.

Cost-benefit considerations

142. Throughout the discussions of this section,it is stated that a cost accumulation andassignment method would be used when it iseconomically feasible. A method is economicallyfeasible if the benefits resulting fromimplementing the method outweigh its costs. It isnot advantageous to use a costing method if itrequires a large amount of resources and yetproduces information of little value to users.

143. As a general rule, directly tracing costs andassigning costs on a cause-and-effect basis aremore expensive than cost allocations, because theyrequire detailed analyses and record-keeping forcosts and activities. However, they arepreferable because they produce more reliable costinformation than cost allocations.

Selecting a Costing Methodology

144. This standard does not require the use of aparticular type of costing system or costingmethodology. Federal entities are engaged in abroad range of diverse operations. A costingsystem appropriate for one type of operation maynot be appropriate for other operations. At manyfederal agencies, cost accounting practices areeither relatively new or experimental. It is tooearly to tell which cost systems are best forspecific types of operations. As experience andresearch in cost accounting progress, reporting


entities and responsibility segments may find apreferred costing methodology for theiroperations.

145. Agency and program management is in the bestposition to select a type of costing system thatwould meet its needs. In making the selection,management should evaluate alternative costingmethods and select those that provide the bestresults under its operating environment.

146. The standard requires that a costingmethodology, once adopted, be used consistently.Consistent use provides cost information that canbe compared from year to year. However, thisrequirement does not preclude necessaryimprovements and refinements to the system ormethodology, so long as the effect of any changeis documented and explained. On the contrary,improvements are encouraged.

147. Several costing methodologies have beensuccessful in the private sector and in somegovernment entities. Four are briefly describedbelow for agency consideration. It should benoted in particular that activity-based costinghas gained broad acceptance by manufacturing andservice industries as an effective managerialtool. Federal entities are encouraged to studyits potential within their own operations. In thefollowing paragraphs, activity-based costing willbe introduced with other well known costingmethodologies, namely job order costing andprocess costing. Standard costing is alsomentioned as an important cost management tool.It is important to note that those costingmethodologies are not mutually exclusive. Bothactivity-based costing and standard costing can beapplied to job order or process costing systems.

Activity-based costing (ABC)

148. ABC focuses on the activities of a productioncycle, based on the premises that (a) an outputrequires activities to produce, and (b) activities


consume resources. ABC systems use cost driversto assign costs through activities to outputs.The ABC cost assignment is a two-stage procedure.The first stage assigns the costs of resources toactivities and the second stage assigns activitycosts to outputs. The procedure is illustrated inthe following figure.[Footnote 37]

[Footnote 37: The figure and the accompanyingdiscussions are based on Robin Cooper, Robert S.Kaplan, Lawrence S. Maisel, Eileen Morrissey, andRonald M. Oehm, Implementing Activity-Based CostManagement (Montvale, NJ: Institute of ManagementAccountants, 1992), pages 9-1.]

Figure 2: The Activity-BasedTwo Stage Costing Procedure

RESOURCES ...(first stage)....ACTIVITIES

ACTIVITIES...(second stage)...OUTPUTS

149. Implementing an ABC system requires fourmajor steps: (1) identify activities performed ina responsibility segment to produce outputs, (2)assign or map resources to the activities, (3)identify outputs for which the activities areperformed, and (4) assign activity costs to theoutputs. Each of the steps is briefly explainedbelow.

(1) Identify activities. This step requires anin-depth analysis of the operating processesof each responsibility segment. Each processmay consist of one or more activitiesrequired by outputs. Activities may beclassified into unit-level, batch-level,product sustaining, and facility sustainingactivities.{Footnote 39] Management maycombine related small activities into largeractivities to avoid excessive costingefforts.

[Footnote 39: Cooper, Kaplan, et. al., page 20.]


(2) Assign resource costs to activities. Thisstep assigns resource costs to theactivities identified in step 1. Theresource costs include direct and indirectcosts usually recorded in general ledgeraccounts. Depending on feasibility and cost-benefit considerations, resource costs may beassigned to activities in three ways: (a)direct tracing; (b) estimation based onsurveys, interviews, or statistical sampling;or (c) allocations.

(3) Identify outputs. This step identifies allof the outputs for which activities areperformed and resources are consumed by aresponsibility segment. The outputs can beproducts, services, or customers (persons orentities to whom a federal agency is requiredto provide goods or services). Omitting anyoutput would result in overcharging costs toother outputs.

(4) Assign activity costs to outputs. In thisstep, activity costs are assigned to outputsusing activity drivers. Activity driversassign activity costs to outputs based onindividual outputs' consumption or demand foractivities. For example, a driver may be thenumber of times an activity is performed inproducing a specific type of output (thetransaction driver), or the length of time anactivity is performed (the duration driver).

150. ABC can be used in conjunction with job order costing or process costing. For example, making direct loans to the public involves a seriesof processes, such as loan origination, credit reviewfor individual applicants, preparing loandocuments, valuation of collateral, making loandisbursements, computing fees and periodicpayments, keeping records, and making collections.These are the "first category" activities thatdirectly affect individual loans. ABC can beapplied to this category of activities.


151. The direct loan operations also involve"second category" activities, such as thoseperformed by loan officers to review and assess aportfolio of loans and make policy changes thataffect an entire portfolio. If ABC is not used,the costs of the loan officers may be allocated todirect loans based on the number of loansdisbursed, or based on the staff hours spent onprocessing all the loans. However, such anallocation tends to be arbitrary, because someloans require more of their time than others.Under ABC, the costs of loan officers would firstbe assigned to their portfolio review and workoutactivities that they perform, then the activitycosts would be assigned to the groups of loans forwhich the activities are performed.

152. A major advantage of using ABC is that itavoids or minimizes distortions in product costingthat result from arbitrary allocations of indirectcosts. By tracing costs through activities, ABCprovides more accurate service or product costs.Experience in the private sector shows that byproviding accurate cost measures, ABC has helpedimprove product costing, strategic pricing, andprofit planning.

153. Also important is that ABC encouragesmanagement to evaluate the efficiency and cost-effectiveness of activities. Some ABC systemsrank activities by the degree to which they addvalue to the organization or its outputs.Managers use such value rankings to focus theircost reduction programs. ABC encouragesmanagement to identify and examine (a) whatactivities are really needed (value-addedactivities) in order to accomplish a mission,deliver a service, or meet customer demand, (b)how activities can be modified to achieve costsavings or product improvements, and (c) whatactivities do not actually add value to servicesor products (non-value-added activities). ABCintegrates with cycle time analysis and value-added analysis.


Job order costing

154. Job order costing is a costing methodologythat accumulates and assigns costs to discretejobs. The word "jobs" refers to products,projects, assignments, or a group of similaroutputs.

155. Each job has a number or code to accumulatecosts. Resources spent are identified with thejob code. Costs are traced to individual jobs tothe extent economically feasible. Costs thatcannot be directly traced are assigned to jobseither on a cause-and-effect basis or allocationbasis.

156. Job order costing is appropriate forresponsibility segments that produce special orderproducts, or perform projects and assignments thatdiffer in duration, complexity, or inputrequirements. Typical situations in the federalgovernment in which job order costing would beappropriate are legal cases, audit assignments,research projects, and repair work for ships,aircraft, or vehicles.

Process costing

157. Process costing is a method that accumulatescosts by individual processing divisions(organization divisions that perform productionprocesses). These processing divisions areinvolved in a continuous production flow, witheach division contributing towards the completionof the end products. The output of a processingdivision either becomes the input of the nextprocessing division or becomes a part of the endproduct.

158. Each division accumulates costs, assigns thecosts to its outputs, and calculates the unit costof its output. For each period, divisions preparea cost and production report, showing the costs,the completed units, and the work-in-processvolume. When a certain number of completed unitsare transferred from a division to the next


division, the costs of those units are alsotransferred and are eventually incorporated intothe costs of the end product. Thus, the cost flowfollows the physical flow of the production. Theunit cost of the end product is the sum of theunit costs of all the divisions.

159. Process costing is appropriate for productionof goods or services with the followingcharacteristics: (a) the production involves aregular pattern of process, (b) its outputconsists of homogeneous units, and (c) all unitsare produced through the same process procedures.In the private sector, process costing is used bysuch industries as flour mills, steel foundries,oil refineries, and chemical processing plants.In government, it may be used by some activitiesthat involve repetitive process procedures todeliver a large volume of similar goods orservices. An example would be making entitlementbenefit payments, which involves a series ofconsecutive processes for reviewing applicationsto establish their eligibility, computing theamount of benefits, and issuing checks.

Standard costing

160. Standard costs are carefully predetermined orexpected costs that can be applied to activities,services, or products on a per unit basis.Horngren describes standard costing as follows:

"A set of standards outlines how a taskshould be accomplished in nonfinancial terms(minutes, board feet) and how much it shouldcost. As work is being done, actual costsincurred are compared with standard costs forvarious tasks or activities to revealvariances. This feedback helps discoverbetter ways of adhering to standards, ofaltering standards, and of accomplishingobjectives."[Footnote 39]

[Footnote 39: Horngren, Charles T. and George Foster,Cost Accounting, A Managerial Emphasis, 7th ed.(Prentice Hall, Englewood Cliffs: New Jersey, 1991),


page 222.]

161. Many organizations frequently review andupdate the standards to assure that they encourageimprovements in efficiency and are within anattainable range.

162. Standard costing helps managers to formulatebudgets, control costs, and measure performance.It can be used in conjunction with job ordercosting, process costing, and activity-basedcosting. It can be applied to specific outputs oractivities, and it can also be applied to aresponsibility segment in aggregate by comparingtotal actual costs with total standard costs basedon outputs produced within a certain time period.Typical situations in the federal government inwhich standard costing would be appropriate areoperations that produce services or products on aconsistently repetitive basis. Agencies areencouraged to use standard costing in thosesituations.

******************************************************APPENDIX A:BASIS FOR CONCLUSIONS

The Nature of Concepts and Standards

163. The difference between accounting conceptsand standards is significant. Statements ofconcepts are more general than statements ofstandards. Standards are intended to be specificguidance and authoritative in nature. Conceptsgenerally do not contain specific recommendationsthat would, when issued by the Board's sponsors,become authoritative requirements for federalagencies. Concepts, instead, provide generalguidance both to the Board and others. They arealso intended to help preparers and users offinancial information better understand federalaccounting and financial reporting. While thedifferences can be easily stated, in reality theline between concepts and standards is often broad


and presents many gray areas for interpretation.

164. When the Board began the project onmanagerial cost accounting, it anticipated theissuance of a recommended Statement of Concepts.Given the meager use of cost accounting withinmany federal agencies, a Statement of Conceptswould provide both the Board and preparers offederal financial reports with overall guidance inthe area and an indication of the future directionthe Board might take in developing standards.However, as the Board and staff began working onthe project, it became clear that action wasneeded to recommend standards for the developmentof cost information.

165. Cost accounting standards were needed becauseusers of financial information, especiallytaxpayers and members of Congress, began puttingmore emphasis on the cost of government programs,products, and activities. The efforts to reducegovernment spending, control the deficit, andimprove government functions necessitatedinformation about the true costs of government.In addition, passage of the CFO Act and the GPRArequired agencies to provide cost information as apart of improving their financial management andreporting. Furthermore, the NPR issued arecommendation that the Board move rapidly torecommend cost accounting standards.

166. The Board established the Cost AccountingTask Force to provide advise and guidance on thecost accounting project. On the task force weremany individuals knowledgeable about costaccounting in the private sector as well as thelimited federal cost accounting activities. Thetask force also recommended the establishment ofcost accounting standards.

167. The Board issued the exposure draft as arecommended statement of standards. The Boardknew, however, that since cost accounting isrelatively new in the federal environment, thefinal statement necessarily would contain someconceptual material. Although the exposure draft


did not present any direct questions concerningwhether parts of the draft should be viewed asconcepts, the issue did arise in public hearingsheld in November 1994, and January 1995. Inaddition, a few respondents who mailed in theircomments addressed the point.

168. Most of those commenting on the issue statedthat they viewed the exposure draft as beingsomewhat conceptual in nature. Many of thosethought that this was appropriate and supportedthe document and the conceptual material itpresented. A few respondents were concerned aboutthe ability to audit some of the standards becauseof the conceptual nature of the document. Severalsuggested that the final statement be segregatedinto concepts and standards and both be issued inone statement.

169. The Board decided that some parts of thefinal statement would contain information thatshould be presented as concepts while other partswould be better presented as standards.Therefore, the final statement should be a"hybrid" issuance containing both concepts andstandards. The title of the document was changedto "Managerial Cost Accounting Concepts andStandards for the Federal Government." (TheBoard decided that the material presented in theexposure draft as the first standard thataddressed the relationship among managerial costaccounting, financial reporting, and budgetingshould be presented as concepts. The othermaterials were more in the nature of standards.)

Relationship Among CostAccounting, FinancialReporting, and Budgeting

170. The Board considers it important forfinancial preparers and users of financial reportsto understand the relationship of cost accountingto the more traditional areas of general financialaccounting, financial reporting, and budgeting.It views cost accounting as a basic and integralpart of an entity's financial management system.


Therefore, the Board included a standard on thisrelationship within the exposure draft.

171. The standard addressed the role of managerialcost accounting in financial management andexplained how it provides cost informationrelevant to budgeting, financial reporting,management control, and many decision makingprocesses. The standard discussed the use of acommon data source for cost accounting, financialaccounting, and budgeting. It explained how thecosts may be determined using different bases ofaccounting and different recognition andmeasurement methods depending upon the intendeduse of the information. It also emphasized theneed for reconciliation of cost data which may bepresented differently in various financialreports. The standard stated that all costinformation, regardless of how presented, shouldbe traceable back to the original common datasource.

172. Most exposure draft respondents who providedcomments on this standard stated that the level ofdetail presented was about right given the desireof the Board to address cost accounting at a highlevel. Most respondents agreed with the need todraw cost accounting data from a common datasource that is also the source of financial andbudgetary data. Some respondents were concernedthat the use of the term "data source" was tooclosely allied with automated or computerizedoperations and that the term may bemisinterpreted. The Board, however, believes thatthe term is adequately explained. In fact, theexposure draft clearly stated that this term wasnot meant to imply the use of computerized systemsfor source information.

173. Data reconciliation for reports containingcost information developed on different bases ofaccounting or using different recognition ormeasurement methods received overwhelming supportfrom respondents to the exposure draft. They saidthat the ability to reconcile differing costinformation is necessary to ensure data integrity,


avoid confusion on the part of financial statementusers, and support stewardship responsibilities.

174. Many who commented on whether the exposuredraft should be viewed as a statement of conceptsor a statement of standards implied that thisparticular standard on relationships of costaccounting to other financial management functionswas basically conceptual in nature. The Boardagreed and concluded that this section is more inthe nature of an explanation of how costaccounting provides useful information and how itfits in with the overall financial managementsystem as opposed to a standard which places arequirement on an entity. The Board decided thatthis material would be better presented in thefinal statement as recommended concepts.

Requirement for Cost Accounting

175. The cost accounting task force recommendedthat a standard be included in the exposure draftrequiring each reporting entity to establish costaccounting systems and procedures for itsactivities. They believed this was necessary toensure the generation of required costinformation.

176. The Board agreed to include the standard inthe exposure draft. The standard defined "system"in a broad way as simply an organized grouping ofmethods and activities designed to consistentlyproduce reliable cost information. Theexplanations and discussions section of theexposure draft contained information on severalfactors that would help managers decide howcomplex and sophisticated their cost accountingsystem should be. It noted that the system couldbe constrained by the (1) nature of the entity'soperations, (2) precision needed in costinformation, (3) practicality of data collectionand processing, (4) availability of electronicdata handling, (5) expected cost of the systemitself, and (6) any specific managementinformation needs.


177. The exposure draft also listed ten minimumcriteria that should be met by all managerial costaccounting systems. Four of these were relateddirectly to the other standards in the exposuredraft (responsibility segments, full costing,costing methodology, and unused capacity costs).The six remaining criteria were concerned withensuring that the cost data produced was reliable,consistent, and useful. These criteria were (1)ensuring the ability to assist in measurement ofperformance, (2) reporting information on a timelyand consistent basis, (3) integrating costaccounting with the standard general ledger, (4)determining a reasonable and useful level of dataprecision, (5) accommodating special informationneeds of management, and (6) documenting thesystem through a manual or handbook. The standardalso allowed for the use of cost findingtechniques and special cost studies or analyses.

178. A large number of respondents to the exposuredraft supported the requirement for costaccounting systems. They stated that such arequirement is necessary to ensure thatappropriate cost data are recorded. They alsosaid that having a requirement for cost systemswill help agencies to more easily meet therequirements of the CFO Act and the GPRA. Somequalified their support by stating that thestandard should allow an exemption for smallentities since establishment of a full costaccounting system may not be cost-beneficial tothem. The Board decided that such an exemptionwould be inappropriate since the standards shouldapply to all federal activities. Furthermore, itshould be far easier for small entities to performmanagerial cost accounting in most cases.

179. Those who were negative toward the standardprovided several reasons. Several expressedconcern about whether accounting standard-settingbodies should require or determine how accountingdata are produced. They noted that otheraccounting standard-setting organizations havestated only what information is required and howthat information is displayed in financial


statements, not how the information is developed.

180. The Board believes that it should not beconstrained by what other standard-setters do.Other standard-setters so far have concernedthemselves mainly with entities' externalreporting. This is understandable because theirmission is to assure that the financial positionand results of operations are presented in a fair,reliable, and consistent manner to financialstatement users who are external to the reportingentity.

181. FASAB is different in that it has determinedthat some of the users of federal governmentfinancial reports are internal to the government.Given the nature and size of the federalgovernment, internal users often do not have thesame type of access to cost information that maybe available in commercial enterprises. Inaddition, the Board views cost accountinginformation as vital to both internal and externalusers. The Board has previously determined in itsObjectives of Financial Reporting that costinformation should be reported to meet the needsof Congress, federal executives, and others.

182. Some respondents to the exposure draft wereconcerned that the requirement for a costaccounting system, along with the system criteria,would not allow management enough flexibility.They seemed to consider the requirement for asystem to mean that cost accounting activities hadto be automated with computers and that softwarehad to be developed and employed in a "full-blown"system, as one put it. They believe that such anelaborate system may not be needed in some caseswhere informal procedures or methods wouldsuffice.

183. The Board does not intend to prescribe anelaborate managerial cost accounting system forevery federal organization. It believed that thestandard proposed in the ED was sufficiently broadto allow managerial flexibility in the systemdesign. However, the Board does recognize that


the term "system" may connotate to some arequirement for computerization and sophisticatedmethodologies.

184. Others stated that establishing therequirement for cost systems should be theresponsibility of OMB or JFMIP. Some of therespondents were concerned about the degree towhich the standard may overlap with JFMIP'sresponsibility to set requirements for costaccounting systems. The NPR recommends settingrequirements for cost accounting systems as aresponsibility of JFMIP, while asking the Board toprovide the cost accounting standards.[|fOOTNOTE40]

[Footnote 40: Office of the Vice President, ImprovingFinancial Management, Accompanying Report of theNational Performance Review (September 1993), page 24.]

185. The Board proposed the requirement forsystems to ensure that cost information is produced and reported in a reliable and consistent manner, and emphasized that this was the intent. The point is not whether the information is produced through the use of a system or through other techniques. The Board believes that, in many cases, cost accounting systems will be established as a natural consequence of requiring cost information. Many government agencies are very large and complex organizations, and it is unrealistic to think that they can develop cost data without relying on a system to do so. Other small agencies or reporting entities may not need a system to develop cost data in a regular, consistent, and reliable manner.

186. The Board, therefore, changed the standard to emphasize producing cost accounting information in a reliable and consistent manner. This can be done through the use of cost accounting systems or cost finding techniques. In either case, the main intent of the original standard is preserved. In addition, the concerns expressed over whether the Board or some other organization should establish


the requirement for cost "systems" are solved.

Responsibility Segments

187. As stated in the ED, a responsibility segment is a component of a reporting entity that is responsible for carrying out a mission, conducting a major line of activity, or producing one or a group of related products or services.

188. The proposal for using responsibility segments in the ED was based on the view that most federal departments and agencies are engaged in more than one line of activity, or producing more than one type of service or product. Furthermore, the activities that an agency performs may differ from each other significantly in required resources and operations. The ED used the Department of Veterans Affairs (VA) as an example. Among its activities, VA administers hospitals and nursing homes to provide health care to veterans, and it also administers direct home loan and loan guarantee programs. These lines of activities are significantly different in operation patterns. The Board believes that for entities that are engaged in diverse activities, identifying responsibility segments is necessary for identifying resources consumed by a distinct line of activity with the outputs of that activity.

189. A majority of respondents supported the requirement for responsibility segments and agreed with the advantages of the requirement. They expressed the view that segmentation provides a basic framework to trace and assign costs to outputs. They also believed that segmentation provides management with the flexibility of choosing a costing methodology that is best suited for a line of activity. The respondents also stated that information generated by responsibility segments can be used to measure performance and to assess accountability.

190. Several respondents, however, presented arguments against using responsibility segments. One such argument was that responsibility segments


would constitute an unnecessary layer that conflicts with financial reporting and budgeting systems. The Board disagrees with this view. A responsibility segment is not, and should not be, an additional layer to the organization and the budget structure. It is an accounting mechanism to capture data generated in operations by various components of an organization in its existing structure. Organization and budget structures can be changed for better management but not for the sake of accounting. Accounting may influence but cannot dictate such changes.

191. The Board believes that accounting by segment will help provide information useful to program managers and other users of financial reports. Entity-wide financial reports provide information on the overall financial position and operating results of an entity in aggregate. Such reports, although useful for many purposes, are not sufficient for cost management. A fundamental undertaking of managerial cost accounting is to match costs with activities and outputs. The purpose of segmentation is to segregate entity- wide data by major lines of activities and their outputs. Information related to each segment should tell managers and other users of financial reports about the segment's specific outputs, the activities performed, and resources consumed to produce the outputs.

192. Furthermore, segment-based reporting need not be in conflict with entity-wide financial reporting. They can use a common source of data, such as accounting data collected by the standard general ledger or the budget execution reports. To perform segment-based accounting and reporting, the general accounting or budget execution data can be traced and assigned to segments. The Statement of Federal Financial Accounting Concepts No. 2, Entity and Display, discusses a reporting approach similar to the segment-based accounting and reporting:

"With some organizations, and evensuborganizations, the activities of one or


more programs or other components are asimportant to the readers of financialstatements as are activities of the entity asa whole. This would be particularly true fora department composed of many bureaus,administrations, agencies, services, etc.,and particularly if their programs aredissimilar. In those instances,consideration should be given to thepreferability of reporting the assets,liabilities, revenues, expenses, etc., ofboth the significant components individuallyand of the entity in its entirety."[Footnote41]

[Footnote 41: FASAB Statement of RecommendedAccounting Concepts 2, Entity and Display, par. 75,page 25.]

193. Another argument against requiring responsibility segments was that the requirement is overly prescriptive and would constrain agency management from selecting among various cost collection methods. The Board believes the standard gives management adequate flexibility in structuring cost accounting. As the standard states, it is for the management of each entity to decide how segments should be defined, and how similar products and services can be grouped into one segment.

194. Furthermore, segments are the largest components of an entity. Management has the flexibility to use any cost collection method within each segment. Within a segment, management may define sub-units, functions, projects, business processes, activities, or a combination of them as cost centers to accumulate costs. The costs accumulated at lower levels can then be aggregated to the segment level.

195. In fact, a segment may contain multiple levels of responsibility or cost centers. For example, if veterans health care is defined as one of the DVA's responsibility segments, this segment may define its hospitals, clinics, and nursing


homes as responsibility centers. Each hospital, clinic, and nursing home may further define their functional units, activities, or business processes as cost centers.

196. Some respondents correctly pointed out that requiring broad responsibility segments, rather than prescribing traditional cost centers, provides opportunity for entities to use activity- based costing or any other costing methods that they may find appropriate.

197. Several respondents who supported the use of responsibility segments interpreted the wording of the proposed standard as requiring that each segment perform managerial cost accounting. They pointed out that for some entities, it is more effective and economical to perform centralized managerial cost accounting. Such centralized accounting is capable of accumulating costs by segments and assigning costs among them. The respondents requested that the wording be revised to provide this flexibility.

198. The Board agrees with this request. The Board believes that entity management should have the discretion to decide whether managerial cost accounting is performed at the entity or segment level, so long as the segment cost information is provided to managers and other users. Thus, the standard recommended in this statement does not require that responsibility segments perform managerial cost accounting.

Full Cost199. As stated in the ED, the full cost of an output produced by a responsibility segment is the sum of direct and indirect costs that contribute to the output, including the costs of supporting services provided by other segments and entities.

200. The outputs of a responsibility segment are considered as cost objects.[Footnote 42] However, in most circumstances, the full costs of intermediate objects, such as activities,


processes, projects, programs, or organization units, must also be measured in order to derive the full costs of their outputs. (See ED Par. 173) The full cost information related to outputs as well as those intermediate objects are useful in measuring efficiency and cost-effectiveness.

[Footnote 42: "Cost object" is defined as an activity,output, or item whose cost is to be measured. In abroad sense, a cost object can be an organizationaldivision, a function, task, product, service, or acustomer. See Glossary.]

Usefulness of full cost information

201. Program evaluation and authorization. Most respondents supported the full cost standard. They recognized that it is particularly important to determine and report the full cost of a program. Information on full costs of programs can be used in program evaluations. Such evaluations typically relate the full costs of programs to their outputs and outcomes. Decision- makers in the Congress and the federal government at all levels as well as the public should be provided with information on the full costs of programs and their outputs. The full cost information, when used with information on program outputs and outcomes, can aid the Congress and federal executives in making decisions on program authorization and modifications.

202. Cost awareness. Most respondents also agreed that the standard has the advantage of promoting cost awareness. Entity and segment managers should be aware of the costs that are incurred or assigned to their operations. Without the awareness, managing and controlling costs are impossible. The full cost information has not been available and will not likely to be without an accounting standard requiring it.

203. Setting fees and prices for government goods and services. Many respondents agreed that full cost should be considered as a primary basis for setting fees and reimbursements for government


goods and services. As pointed out in the ED, it is a federal policy that, with certain exceptions, user charges (prices or fees) should be sufficient to recover the full cost of goods, services, and resources provided by the federal government as sovereign.[Footnote 43] The policy further states that when the government sells goods and services under business-like conditions rather than in a sovereign capacity, user charges should be based on market prices and may yield a net revenue in excess of the full cost. The objectives of the policy are to: (1) ensure that government goods and services are provided on a self-sustaining basis, (2) promote efficient allocation of national resources, and (3) allow fair competition with comparable goods and services provided by the private sector.

[Footnote 43: OMB Circular No. A-25, User Charges.]

204. To implement the policy, full cost information is necessary. Only with reliable full cost information can management ensure that user charges fully recover the costs.[Footnote 44] Even in some exceptional cases in which user charges are exempted or restricted by law, agencies that provide the goods and services would nevertheless need the full cost information to assess the extent to which costs are not recovered.

[Footnote 44: The standard of determining full costdiscussed in this document, however, should not beconstrued as a standard for setting fees, prices, andreimbursements. Federal entities should comply withlaws and regulations related to pricing policies ingeneral and for specific types of goods and services.Those laws and regulations (including OMB Circular A-25) may prescribe costing requirements other than thefull cost standard discussed in this document. Fullcost defined by this standard can serve as a point ofreference for managerial decisions. However, it is notintended to supersede any costing concept thatmanagement is required or permitted by law to use inpricing goods and services.]


205. Making cost comparisons. Respondents agreed that the full cost of outputs provides a valid basis for cost comparisons. One of them emphasized the importance of calculating the unit cost of output on the full cost basis. The Board agrees with his view. If an output can be measured in units, its unit cost should be calculated on the full cost basis.

206. The unit cost of a service or product, calculated on a full cost basis, can be compared with a similar service or product produced by other entities either in the federal government or in the private sector. The comparison would not be valid if it is not conducted on a full cost basis.

207. One of the available cost management tools is trend analysis. In trend analysis, unit costs of a service or product over a number of consecutive periods are examined to find a trend of increases or decreases. This analysis can be valid only when the unit costs of all periods are measured on a consistent basis, such as the full cost basis. When the full cost basis is used, the analyst can further examine the components of the unit cost, such as direct labor and material costs, overhead costs, and costs of services received from other segments or entities. Through examining the various components of the full unit cost, program managers can pinpoint specific areas that contributed to cost increases or decreases.

208. If activity-based costing is used, the cost components would be associated with activities. The trend analysis for activity-based cost components can provide information related to the efficiency of the activities. Managers can also analyze the extent that the individual activities add value to program outputs and objectives.

Limitations of Full Cost Information

209. Several respondents cautioned the Board against "uncritical advocacy" of full costs. They pointed out that full cost is not relevant to all decision-making situations. They explained that


some decisions require other cost concepts such as variable, differential, or incremental costs. Thus, some of them said that the Board should not singularly emphasize full cost.

210. The Board is aware of the notion that different cost concepts should be used for different purposes so that the use of a cost concept is relevant to a particular decision- making purpose. For this reason, the Board discussed the limitations and usefulness of full cost in the ED at length. (See ED pars 133 through 146.) Quoting from Anthony and Young, the ED pointed out that full costs are not appropriate for alternative choice decisions such as the decision to (1) add or drop a product or service, (2) perform work in-house or contract out for it, and (3) accept or reject a special request. For these decisions, the appropriate information is differential costs.[Footnote 45]

[Footnote 45: Robert N. Anthony and David W. Young,Management Control in Nonprofit Organizations, 5th ed.(Burr Ridge, Illinois: Richard D. Irwin Co., 1994) page235.]

211. However, the full cost standard is an accounting standard, rather than a cost analysis or decision-making standard. It requires that full cost information be compiled and reported through cost accounting. In no way does it limit cost analysts and decision-makers to the use of full cost alone in all situations. The Board believes that when the full cost information, instead of any portion of it, is made available, analysts and decision-makers will have a comprehensive data source to develop the cost concepts that they need in their analyses.

212. Some respondents pointed out that full cost requires a complex process of cost assignments and allocations. The Board believes that the assignment of indirect costs is a necessary procedure to obtain full cost. It can be performed through an appropriate costing methodology. As discussed in the costing


methodology section of the ED, some modern costing methodologies are available to make rational and reliable cost assignments. However, the Board must caution that the full cost information, like any other accounting information, can only be as good as how it is prepared. For example, it can be unreliable or inaccurate, if arbitrary or irrational cost allocations are used excessively. Thus, the Board recommended a costing methodology standard. Program managers should critically review costing methodologies and techniques used to derive the cost information.

Inclusion or Exclusion of Certain Costs

213. A number of respondents were opposed to the inclusion of accrued employee benefit costs and costs of services provided by other entities that are not reimbursed. (The subject of inter-entity costs will be discussed in the next section.) They argued that these costs are not funded with their budgetary resources and are beyond their control. A large portion of employee benefit costs, including accrued retirement benefit costs, are funded through appropriations to trust funds managed by OPM and DoD. The Board believes that as a principle, full cost should include the costs of all resources applied to a program, activity, and its outputs, regardless of funding sources. For financial reporting, the Board has stated its position that the full costs of employee pension and other retirement benefits determined on an actuarial basis, including the amounts that are funded to the trust funds directly, should be recognized as an expense in the employer entity's financial reports.[Footnote 46] The Board does not find a good rationale to depart from this principle in managerial costing.

[Footnote 46: FASAB Exposure Draft, Accounting forLiabilities of the Federal Government (Nov. 1994),pars. 80-99, pages 32-46.]

214. The ED states that some costs should be recognized as a period expense rather than the costs of goods and services (output costs).


Examples include the costs of "other post employment benefits" (OPEB), reorganization costs, and acquisition costs of Federal "mission" and "heritage" property, plant, and equipment which are recognized as expenses at the time of acquisition.[Footnote 47] These costs will be recognized as expenses for the period in which the related events take place, and are referred to as "period expenses." The ED explained that since these expenses do not contribute to the outputs of the period in which they are incurred, they should not be included in the output costs.

[Footnote 47: "Federal mission PP&E" and "heritageassets" are explained in FASAB Exposure Draft,Accounting for Property, Plant, and Equipment (February28, 1995), pars. 98-115, pages 29-33.]

215. The OPEB costs, for example, may be recognized as expenses for a period in which a reduction in force or an employee injury takes place.[Footnote 48] It is not appropriate to attribute the entire OPEB costs to the output costs of that period. Several respondents expressed the view that OPEB costs should be included in full cost. There is no doubt that OPEB costs, as well as other period expenses, are part of the full cost of an entity or a program. They may also be part of the full costs of outputs over many years in which the employees contributed to the production of the outputs. However, they are not the production costs for the period during which they are incurred. Thus, the Board concluded that in cost studies, management may distribute some of the period expenses, such as OPEB costs, to outputs over a number of past periods if (a) experience shows that the OPEB costs are recurring in a regular pattern , and (b) a nexus can be established between the OPEB costs and the outputs produced in those past periods. The Board finds no reason to change this position.

[Footnote 48: FASAB Exposure Draft, Accounting forLiabilities of the Federal Government (Nov. 7, 1994),pars. 100-102, pages 47-48.]


216. Some respondents contended that full cost should include unused capacity costs. As will be explained in a later section on unused capacity costs, the Board has decided not to recommend a standard on measuring unused capacity costs. Thus, to assure valid cost comparisons, full costs should not exclude unused capacity costs.

Controllable and Uncontrollable Costs

217. Some respondents believed that the managers of a responsibility segment should be held accountable only for costs that they can control, and their performance should not be evaluated for costs beyond their control. They found that the full cost reporting would obscure the distinction between controllable and uncontrollable costs. For performance measurement or other purposes, some entities may want to make a distinction between controllable and uncontrollable costs with respect to an individual responsibility segment or a cost center. The full cost information need not interfere with this distinction. This standard does not require the use of full cost for internal reports. If some entities choose full cost for internal reporting, the internal reports can provide a distinction between controllable and uncontrollable costs with respect to individual segments.

218. Ultimately, most costs are controllable at a certain level of the entity. If some of them are not controllable at a lower level of the organization, they may very well be controllable at a higher level. Each segment should concern itself with the costs that are assigned to it on a cause-and-effect basis. These costs are often incurred because of a segment's demand and use of services from other segments or entities. Although the service-receiving segment has no control over the efficiency in producing the service, it can influence the costs by changing the demand for the service. For an entity's top management, full cost reporting provides it with an overview of how the entity's various costs, including the general and administrative costs,


are incurred and assigned to the entity's segments. The full cost reporting also makes the entity's top management aware of the costs of services that it receives from other entities. The management can closely review those costs and determine whether actions are needed to control them.

Centralized Accounting

219. The proposed standard in the ED states that "Responsibility segments should be capable of measuring the full costs of their outputs." Several respondents stated that the full costs of segments, programs, and their outputs can be more effectively measured by entities through centralized accounting, rather than by individual segments. They further stated that it would not be cost-beneficial for segments to measure and report the full costs of their activities and outputs on a regular basis (such as monthly basis). The Board agrees that many entities may find it more economical and effective to measure full costs through centralized accounting. Moreover, the Board believes that it should be for entity management to decide as to how frequently the full cost information should be made available in its internal reports. Thus, the wording of the standard has been changed. The full cost requirement is now limited to external reporting via general purpose financial reports.

Costs of Outcomes

220. A respondent suggested that in addition to the full cost of outputs, the standard should also require reporting the full cost of program outcomes. As discussed in the ED, the Board believes that performance measurement of a program requires three major elements: the full cost of the program, its outputs, and its outcomes. (See ED pars 37 and 38) The full cost of a program and its outputs, once measured according to this standard can be related to the outcome of the program to measure its cost effectiveness.


221. This standard does not require a direct measurement of the cost of outcomes because in most instances, program outcomes need to be measured with methodologies beyond those discussed in this document. GPRA defined "outcome measure" as an "assessment of the results of a program activity compared to its intended purpose."[Footnote 49] Many programs' policy objectives and intended results are socio-economic or scientific in nature, or involve national defense. The assessment of the program results require expert knowledge in those areas. Thus, unlike costs and outputs, outcomes are not always measured in quantitative or monetary terms.

[Footnote 49: The Government Performance and ResultsAct of 1993, PL 103-62, sec 4.]

222. Moreover, unlike costs and outputs that are measured for each accounting and reporting period, such as a quarter or a year, outcome measurement may be long-term in nature. For example, the Senate Report on GPRA states that "Outcome measurement cannot be done until a program or project reaches a point of maturity (usually at least several years of full operation for programs continuing indefinitely) or at completion." Although all programs cost money, some of them may produce positive results, while others may produce no results or negative results.

223. Because of the complexities in measuring outcomes, the costing principles and methodologies discussed in this document cannot be used to measure the cost of outcomes. The Board believes that the full cost of a program and its outcome should be measured independently, using methodologies appropriate to costs and to outcomes. Once each of them is measured, they can then be related to review the cost-effectiveness of the program.

Inter-Entity Costs

224. It is not unusual in the federal government for one agency to provide goods or services to


another agency. Sometimes this may be required by law, and often it is a very efficient method of conducting business for the agencies involved and for the government as a whole. In many cases, the agency receiving such goods or services will reimburse the providing agency in accordance with some agreed-upon price. Often, however, there is no charge, or there is a charge that is not sufficient to cover the providing agency's full cost. When such "free" or lower-than-cost items are used in the production of the receiving agency's outputs, the result can be an understatement of the full cost of final outputs by the receiving agency.

Survey of Non-Reimbursed Costs

225. The Board recognized that these non-reimbursed or under-reimbursed goods and services could distort the determination of a reporting entity's full cost of outputs, but it was uncertain of the extent to which this occurs. To identify examples of non-reimbursed inter- entity costs, the Board conducted a limited survey of federal agencies. Of the 22 agencies responding to the survey request, 13 indicated that they provide some type of service or good that is not reimbursed. These covered a wide range of activities, but most of the costs involved were for salaries and salary-related benefits of those employees performing the work. In most cases, the costs were funded through direct appropriations to the providing agencies; however, those agencies could not specifically identify the total amounts involved. Several provided estimates, which ranged from $360 thousand dollars per year to about $180 million per year. Several examples of non-reimbursed inter-entity activities identified in the survey are listed below by providing entity:

-- Department of Agriculture -- Provides marketdata, pesticide data, food specificationinformation, water supply forecasts, and


other agricultural information. Thirty-sixfederal agencies regularly receive all orsome of this information.

-- Department of Commerce -- Provides accountingand grant administration services, computeraccess and reports, and consultation servicesto several agencies.

-- Department of State -- Provides space andfacilities for other agencies in itsbuildings in the U.S. and overseas.

-- General Services Administration -- In somecases, it provides policy and regulatorydevelopment services, property managementservices, and contract award andadministration to other agencies withoutreimbursement.

-- National Science Foundation -- Administers aresearch grant program on engineering andcomputer science for the Department ofDefense.

226. The Board noted that the survey wasrestricted to non-reimbursed costs betweendifferent agencies. As such, the results did notnecessarily represent all of the kinds and amountsof transactions and costs between differentreporting entities. The survey was also limitedto those non-reimbursed costs which the agenciescould easily identify in order to respond quicklyto the questionnaire. Nevertheless, there wereindications that some non-reimbursed costs may besignificant in amount.

Usefulness of Recognition

227. Some respondents to the exposure draftstatedthat recognition of inter-entity[Footnote 50]costs would have limited usefulness for managerssince they cannot control the cost of itemsprovided by other agencies. In somecircumstances, they cannot control the amounts of


inter-entity goods or services that must be usedin the production of their outputs.

[Footnote 50: Full cost, as discussed in the full coststandard, contemplates both intra-entity costs andinter-entity costs applicable to a responsibilitysegment. This standard elaborates on inter-entitycosts. Intra-entity costing is accomplished throughthe costing methodology selected for use within thereporting entity since these costs are passed amongresponsibility segments.]

228. The Board realizes that recognition of non-reimbursed or under-reimbursed inter-entity costswill not always have the same degree of usefulnessfor all levels of management. However, as statedin the standard on full costs, to fully accountfor the costs of the goods and services theyproduce, reporting entities will need to includethe cost of goods and services received from otherentities. Cost reduction and control, performanceevaluation, and process improvement depend onknowledge of the full costs of producing outputs,including production costs incurred by otherfederal entities. These costs are most importantfor use by the entity's top-level management (andto a lesser degree by line managers) incontrolling and assessing the operatingenvironment and in making decisions about how bestto acquire those goods and services. Knowledge offull cost, including the extent of inter-entitycosts, is also important to external users,especially the Congress and taxpayers, in makingdecisions concerning various programs andallocating resources throughout the government.

229. In addition, the Board believes that,withoutthe recognition of non-reimbursed and under-reimbursed inter-entity costs, the receivingentity has little incentive to control the use ofthese resources. While they may appear to be"free" to the receiving entity, the costs areabsorbed somewhere in the government. If thereceiving entity were charged for these costs,top-level management would then have more


incentive to economize and control the use ofthese resources as well as make better decisionsconcerning how and where to acquire them. Thiswould help reduce overall costs to the taxpayerand provide the other benefits associated withfull-costing by responsibility segment.

230. The recognition of all inter-entity costs isalso important when an entity produces goods orservices that are sold outside of the federalgovernment. For the entity to recover thegovernment's full cost on the sale, knowledge ofthe total cost, including costs incurred by otherfederal entities, is vital to the establishment ofan appropriate price.

The Use of Estimates

231. The standard places the responsibility ontheproviding entity to supply the receiving entitywith information on the full costs of non-reimbursed or under-reimbursed inter-entity goodsand services. This is appropriate since only theproviding entity is likely to have suchinformation. Implementation of the standard onfull costing should make this requirement fairlyeasy for the providing entity to fulfill. If, forsome reason, the providing entity cannot or doesnot supply the cost information, the receivingentity has no way to recognize the costs otherthan through estimation.

232. The Board anticipated this possibility, andrequires the receiving entity to use an estimateof the cost of those goods and services if theactual cost information is not provided. Theestimate must be reasonable and should be aimed atdetermining realistic costs incurred by theproviding entity. However, if such a costestimate cannot be made, the receiving entity maybase the estimate on the market value of the goodsor services.

233. Some respondents to the exposure draftstated


that the use of estimates would be too problematicand unreliable and that the receiving entity wouldnot have enough information to make the estimate.Some were concerned that the use of estimateswould cause arguments between reporting entitiesover the cost. Others were concerned that someentities do not have experienced personnel to makesuch estimates. A few were concerned about theaudit implications of using an estimate.

234. Some respondents expressed concern over thepossible use of market values in making theestimate. Some of these respondents stated thatgovernment-type goods and services are not oftenproduced outside government and, therefore, suchmarket values may not exist. Others stated thatmarket value does not always bear a directrelationship to true cost or that market valueschange too rapidly to be of any use.

235. The Board realizes the problems associatedwith the use of estimates. However,implementation of the other managerial costaccounting standards in this statement by theproviding entities should considerably lessen theneed for receiving entities to make estimates ofinter-entity costs. The Board also believes that,if the inter-entity costs meet the recognitioncriteria established by the standard, and costinformation is not received, then use of areasonable estimate of cost is preferable to norecognition at all.

236. Estimates are often used in accounting andfinancial reporting. The recognition of costbased on estimation is not new and can be reliableso long as the estimate is reasonable and based ona rational and systematic method. The Board alsorealizes that the use of estimation necessarilyimplies the use of professional judgement. Thisdoes not negate the value of the estimate to usersof the financial information and should notpresent a problem in relation to auditrequirements.

237. The Board realizes that market values may


notalways be available for many kinds of inter-entitygoods and services. Nevertheless, if such valuesare available, they can be a good basis forestimating cost if no other basis can beestablished. Although market values may not bedirectly related to costs of production and theymay fluctuate, they may also be viewed as a fairlyreliable guide to the costs an entity might haveto incur to obtain inter-entity goods and servicesfrom a non-governmental source. As with thedetermination of all estimates, use of marketvalues as an estimation basis requires the use ofjudgement and professional care.

238. The Board also realizes that there may besome implementation problems such as disagreementswith providing entities over an estimated cost orwith the lack of trained personnel to makeestimates. These problems are of a practicalnature and can be resolved by management. In thatregard, they are not unlike other problems facedwhen implementing any new or changed accountingstandard such as making changes to systems andmethods and training personnel on the newrequirements. Both providing and receivingentities should work closely with each other toresolve any costing problems just as they would tosolve any non-accounting related situations.

Recognition Criteria

239. It is clear to the Board that therecognitionof each and every non-reimbursed or under-reimbursed inter-entity cost is not possible. Thefederal government is a very large and complexentity and it is normal to expect some flow ofgoods and services between its activities as anatural and reasonable method of completingmissions and objectives. The Board decided thatonly certain non-reimbursed or under-reimbursedinter-entity costs should be addressed. Thestandard, therefore, includes criteria forrecognition which will limit the application ofthe standard to only those items deemed most


significant and important.

240. The criteria address the materiality of thenon-reimbursed inter-entity cost, whether it is apart of broad and general support for allentities, and whether it is needed to helpdetermine a price to non-governmental entities.The materiality criterion considers materiality inthe context of the importance of the item to thereceiving entity. Under this criterion, whetheran item of inter-entity cost is recognized dependsupon three points. The first of these issignificance to the receiving entity, i.e. whetherthe item is important enough that managementshould be aware of its cost in decision makingcircumstances. The second is the degree to whichthe goods or services are an integral andnecessary part of the receiving entity's output.The third is the degree to which the good orservice can be matched to the specific receivingentity with reasonable precision.

241. The criterion of broad and general supportrecognizes that some entities provide support toall or most other federal entities, generally as amatter of their mission. The costs of broad andgeneral services should not be recognized by thereceiving entity when no reimbursement has beenmade. However, if the service is an integral andnecessary part of the receiving entity'soperations and outputs, those costs should berecognized.

242. The criteria also recognize that there arecertain cases in which inter-entity costs need tobe recognized because there could be an effectupon a resulting price to a non-governmentalentity. If a federal entity sells outputs to anon-federal entity, it is usually required torecover the full cost of those goods or services.While cost is not the sole determinant of finalprice, knowledge of the actual full cost ofproduction to the government as a whole isnecessary to ensure that the price isappropriately established at a level that willrecover all costs.


243. Most of the respondents to the exposuredraftagreed with the recognition criteria. However, afew were concerned about how the criteria might beinterpreted and whether the standards were toogeneral in nature. The Board realizes thatconsiderable judgement is required to apply thesecriteria and notes that the specific facts andcircumstances in each case must be considered.This concern, along with other implementationconcerns, led the Board to make certain decisionsabout implementation discussed below under"Implementation Issues."

Consolidation

244. The standard requires that, when non-reimbursed or under-reimbursed inter-entity costsare recognized, the receiving entity shouldrecognize the full costs of the goods or servicesreceived as an expense (or asset) and, to theextent that reimbursement is less than full cost,the difference is to be recognized as a financingsource. At the same time, of course, theproviding entity would continue to recognize thefull costs of goods and services provided, and anyoff-setting reimbursements, in its accountingrecords. Several respondents to the exposuredraft were concerned about the possibility of"double-counting" of costs and others raisedconcerns about the ability to eliminate thesetransactions in consolidations.

245. Both the providing entity and the receivingentity are separate reporting entities. Eachshould recognize in its accounting records andfinancial reports the true costs of operations andany revenues received. The providing entityincurs a cost in providing the goods or serviceseven though they are sent to another entity. Itmay also receive a partial payment orreimbursement. These transactions and eventsshould be reflected in its accounting. Thereceiving entity, as a separate reporting entity,should also recognize its total cost of


production. The full cost of non-reimbursed orunder-reimbursed goods or services ultimatelycontributing to its outputs should be reflected inthe costs of production. To the extent thatreimbursement is not made for those costs, thereceiving entity is utilizing a separate source offinancing, namely the providing entity. Again,this fact is reflected in the accounting. Theresult is that costs recognized but not actuallypaid are off-set by the imputed financing source.While the entity's financial position is notaffected, the real costs of production arereflected.

246. The only possibility for "double-counting"ofcosts occurs when consolidated financial reportsare prepared for a reporting entity that includesboth the providing entity and the receivingentity. In preparing such statements, thestandard calls for elimination of the inter-entitytransactions. In effect, this is no differentfrom the elimination of transactions for whichfull reimbursement has been made. The onlyadditional transaction to be eliminated is therecognition of the imputed financing source by thereceiving entity. The recognition of costs byboth the providing entity and the receiving entityand any actual reimbursements would be eliminatedanyway if payment for the inter-entity costs weremade.

247. The Board realizes that identification andtracking of transactions that must be eliminatedfor consolidated reports can become complex anddifficult. However, this is a practicalimplementation problem that management should beable to overcome through the use of transactioncoding or some other identification method. Itlikely will require changes in methods and systemscurrently in use and may require additionaltraining of personnel. The Board has decided upona method to ease implementation problems asdiscussed below.


Implementation Issues

248. As discussed above, the Board realizes thatthere may be problems in implementing the standardon inter-entity costing. Recognition of non-reimbursed or under-reimbursed inter-entity costsis a new concept to federal entities and involves

a new way of thinking about costs. There isconcern that application of the standard may beinconsistent among federal entities. In addition,there could be problems, particularly at first, indeveloping estimates of costs; in revisingaccounting systems and procedures to accommodatethese requirements; and in training personnel toaccomplish the task. Furthermore, the Boardrecognizes the concern that some have about theelimination of inter-entity cost transactions forconsolidated reporting since the accountingprocedures may be complicated.

249. As a result of these problems and concerns,the Board has expressed the need to take ameasured, step-by-step, practical approach toimplementation of this standard. Therefore, theBoard has decided that, in implementing thestandard, it recommends that OMB, with assistancefrom the FASAB staff, should identify the specificinter-entity costs for entities to beginrecognizing and OMB should then issue guidanceidentifying those costs. OMB should consider therequirements of the standard including therecognition criteria in developing the guidanceand it should also consider suggestions andinformation provided by Treasury, GAO, and otheragencies. The Board anticipates the largest andmost important inter-entity costs will beidentified first, followed by others as entitiesgain experience in the application of thestandard. This approach is seen as a practicalway to ensure uniformity in the application andimplementation of the standard and to provide timeand experience in overcoming any other practicalproblems which may arise. Also, the Board mayrecommend specific inter-entity costs forrecognition in possible future recommended


standards.

Costing Methodology

250. The ED discussed cost accumulation andassignment principles. The ED states that costsshould be accumulated by responsibility segments,and the accumulated costs should be classified bytype of resource such as costs of employees,material, capital, utilities, rent, etc. The EDstates that "The accumulation of costs byresponsibility segments does not mean that eachresponsibility segment must have its ownaccounting system. The reporting entity may havea centralized accounting system, but the systemshould be capable of identifying costs withresponsibility segments." (See ED par. 170)

251. The ED discussed three cost assignmentprinciples: (a) directly tracing costs whereverfeasible and economically practical, (b) assigningcosts on a cause-and-effect basis, or (c)allocating costs on a reasonable and consistentbasis. These principles apply to costs ofservices provided by a segment to other segments,as well as assigning costs to ultimate outputs ofa segment.

252. The ED then provided brief descriptions ofavailable costing methodologies: activity-basecosting (ABC), job order costing, process costing,and standard costing. The ED pointed out thatthese costing methodologies are not mutuallyexclusive. For example, standard costing can beused within ABC. ABC and standard costingcombined can then be used with either job ordercosting or process costing.

253. Most respondents believed that therequirement for cost accumulation byresponsibility segment is appropriate. Some ofthem stated that costs are accumulated at levelslower than segments such as cost centers,processes, or activities within a segment. Suchaccumulation is consistent with the standard solong as the costs will be aggregated at the


segment level. Some of the respondents statedthat the requirement is currently feasible becausetheir systems are designed to accumulate expensesby segments and by resource types. Others,however, stated that they must upgrade theirgeneral accounting systems in order to meet thestandard requirement.

254. All the respondents agreed with the costassignment principles. One respondent, whilesupporting the principles, stated that theprinciples should be explicitly ranked bypreference. The Board intended to express anpreference among the principles. It stated in theproposed standard that direct cost tracing shouldbe used "wherever it is feasible and economicallypractical." The Board further stated in the EDthat "for the costs that are not directly tracedto outputs, it is preferable that they be assignedto them on a cause-and-effect basis." (See EDpar. 182) However, for cost-benefitconsiderations, assigning costs by allocationscannot be avoided. The Board emphasized that costallocations should be performed on a rationalbasis. It also cautioned that allocations can bearbitrary and thus may result in distortions.(See ED par. 190) To make the intent ofpreference more explicit, the Board has addedwords to the standard to indicate that theprinciples are listed by preference.

255. All the respondents approved thedescriptionsof available costing methodologies. Some of themstated that the materials included are clear andprovide adequate guidance. The respondents agreedwith the Board's position that because federalactivities are highly diverse, it is not practicalto require a particular costing method for aparticular type of activity at this time.However, it is appropriate to require that eachentity select a costing methodology that is bestsuited to its operations and use that methodologyconsistently.

256. The Board encouraged government entities to


study the potential use of ABC in their operations(ED par. 200). This was well received by therespondents. Eighteen respondents supported ABC.Most of them said that ABC can be effective whencombined with any of the other costingmethodologies. Seven respondents from federalagencies stated that they believed ABC isappropriate for their activities and wereconsidering using it. In addition, tworespondents stated that the use of standardcosting should also be encouraged. The Boardcontinues to believe that as federal agencies aregoing through stages in the development of theirmanagerial costing, more sophisticated and refinedcosting methods, such as ABC and standard costing,should be considered and used to minimizearbitrary cost allocations and to improve fullcost information.

257. The Board considered whether the costingmethodology section should be recommended as aconcept or a standard. It concluded that itshould be a standard. The Board believes thatcost accumulation and assignment principlescontained in this section are definitive andshould be followed by federal entities. Only byadhering to the principles and by continuousrefinement of costing methodologies, can reliablefull cost information be achieved.

Unused Capacity Costs

258. The ED proposed a standard, which, ifadopted, would have required that entities measurethe cost of unused operating capacity and reportit as a separate expense. For this purpose, someentities, such as DoD, must separate operatingcapacity from "readiness capacities" which arereserved for war and emergency mobilization ratherthan normal operations. The operating capacitycan be measured in terms of "practical capacity"which is the maximum units of output that theavailable capacity can produce taking the normal


stoppage and interruptions into consideration.Unused capacity is the excess of practicalcapacity over actual outputs.

259. A number of respondents appreciated theimportance of the proposed requirement. Theystated that capacity cost information would bevery useful in improving the cost and capacitymanagement of federal agencies. Severalrespondents from the private sector urged that theproposal be adopted immediately.

260. Most respondents from federal agencies,however, stated that capacity measurements involvevery complex issues and are not feasible toimplement at this time. If the proposedrequirement were adopted, agencies would encountertwo major types of difficulties. First, they lackguidance on defining and measuring various typesof capacity. For example, respondents from DoDstated that it is difficult to develop criteriathat can be used to differentiate defenseoperating capacity costs from mobilizationcapacity costs. Civilian agencies engaging inadministrative, policy making, and regulatoryactivities also indicated difficulties in definingtheir practical capacities. Second, respondentsof many agencies stated that they do not have theaccounting capability to provide reliable capacitymeasures. Without such capability, unusedcapacity costs could be improperly estimated andthe resulting information could be misleading.

261. Many respondents were also opposed to theproposed standard on the basis of cost-benefitconsiderations. They estimated that accountingfor capacity costs would require substantial timeand efforts to implement. This would require theuse of their limited accounting personnel andequipment. Respondents from some agencies do notperceive that they have an over-capacity problem.Thus, it is very uncertain whether capacityaccounting results, if produced, could be used toimprove their operations.

262. After considering the responses to the ED,


the Board is convinced that it is premature torecommend capacity accounting either as a standardor as a concept. The Board is aware that federalagencies have limited personnel and otherresources for accounting. They must devote thoselimited resources to improving general financialreporting and to establishing the more fundamentalelements of managerial cost accounting. Thus, itwould not be cost beneficial to implement capacitycosting at this time.

263. Managing capacity costs is a part of costmanagement. Although this document does notrecommend a standard for measuring capacity costs,the full cost information required by the fullcost standard will help management in identifyingcapacity utilization problems. Some respondentsstated that the capacity accounting concepts wouldbe useful to capital intensive, industrial-typeactivities and activities that deliver repetitiveservices that are measurable in units. The Boardis aware that there are on-going research effortson the subject in the private accountingcommunities. Thus, the Board may reconsidercapacity accounting in the future.

Effective Date

264. The Board holds the view that managerialcostaccounting has been needed across the federalgovernment for a long time. Since the standardsare quite general and address only the highestlevels of cost accounting, the Board felt thatthey should be implemented quickly. The earliermanagerial cost accounting is started, the earlierthe benefits will be seen in managing andcontrolling federal programs and activities. TheBoard also believes that an effective date farinto the future would not serve to quickly changethe government's tendency to neglect costaccounting. Therefore, in the exposure draft, theeffective date was set for fiscal periodsbeginning after September 30, 1995 (i.e.,beginning in fiscal year 1996).


265. A majority of respondents to the exposuredraft commented that this date was too early andsaid that they foresee problems withimplementation at September 30, 1995. Manyreasons were given for a delay in implementation.Chief among these were (1) difficulty in obtainingfunding to make necessary changes in financialsystems before September 30, 1995, (2) a lack oftrained accounting personnel and equipment, and(3) a need for time to develop or modifyappropriate cost accounting methodologies andsystems and develop management awareness andsupport. Respondents suggested implementationdates ranging from one to five years after thefiscal year 1996 date given in the exposure draft.

266. The Board recognized the validity of theconcerns of many respondents over funding,training, and development of costing activities.However, it also recognized that federal agenciesmust be able to develop cost information very soonto meet the requirements of the GPRA. It alsonoted that reporting entities do not have topossess sophisticated cost accounting systems tomeet the requirements in these standards. Federalagencies can take a gradual approach to thedevelopment of cost systems, if necessary, whiledeveloping basic cost information through othermeans in the short term.

267. Nevertheless, the Board agreed that theimplementation date in the exposure draft may be aproblem for many federal agencies since costaccounting is relatively new to most of them andthe recommended implementation date is very near.The Board decided, therefore, to delay theimplementation date by one additional year andmake the standards effective for periods beginningafter September 30, 1996, with earlierimplementation encouraged.

268. Early on in the development of themanagerialcost accounting project, the task force determinedthat many problems can result in cost accountingfrom the use of similar terms to mean different


things. It concluded that the use of consistentcost accounting terminology is necessary to avoidconfusion and mis-communication. Therefore, itrecommended that the Board attach a glossary tothe exposure draft which would define many of thecost accounting terms used.

269. The Board agreed with this recommendation.It also decided that the establishment of uniformcost accounting terminology within the federalgovernment is so important that the glossaryshould contain not only definitions for terms usedin the statement, but also definitions for otherimportant cost accounting terms even if thoseterms are not used directly in the text of thestatement. This glossary would serve as thebeginning of a uniform and consistent costaccounting terminology for use within the federalgovernment.

270. Comments were received from only onerespondent to the exposure draft concerning theglossary. That respondent did not suggestchanging any of the definitions provided in theglossary, but only suggested some additions. TheBoard decided that the glossary is sufficient forthe time being and should be retained in the finalstatement as an appendix. However, it alsodecided that it may issue additions to theglossary at a later date as more federal agenciesgain experience in the development of costinformation, and as the need for additionalstandard definitions becomes apparent.

******************************************************APPENDIX B:GLOSSARY

Activity - The actual work task or step performed inproducing and delivering products and services. Anaggregation of actions performed within an organizationthat is useful for purposes of activity-based costing.

Activity Analysis - The identification and description


of activities in an organization. Activity analysisinvolves determining what activities are done within adepartment, how many people perform the activities, howmuch time they spend performing the activities, whatresources are required to perform the activities, whatoperational data best reflect the performance of theactivities, and what customer value the activity hasfor the organization. Activity analysis isaccomplished with interviews, questionnaires,observation, and review of physical records of work.It is the foundation for agency process value analysis,which is key to overall review of program delivery.

Activity-Based Costing - A cost accounting method thatmeasures the cost and performance of process relatedactivities and cost objects. It assigns cost to costobjects, such as products or customers, based on theiruse of activities. It recognizes the causalrelationship of cost drivers to activities.

Actual Cost - An amount determined on the basis of costincurred including standard cost properly adjusted forapplicable variance.

Avoidable Cost - A cost associated with an activitythat would not be incurred if the activity were notperformed.

Common Cost - The cost of resources employed jointly inthe production of two or more outputs and the costcannot be directly traced to any one of those outputs.

Common Data Source - All of the financial andprogrammatic information available for the budgetary,cost, and financial accounting processes. It includesall financial and much non-financial data, such asenvironmental data, that are necessary for budgetingand financial reporting as well as evaluation anddecision information developed as a result of priorreporting and feedback.

Controllable Cost - A cost that can be influenced bythe action of the responsible manager. The term alwaysrefers to a specified manager since all costs arecontrollable by someone.


Cost - The monetary value of resources used orsacrificed or liabilities incurred to achieve anobjective, such as to acquire or produce a good or toperform an activity or service.

Cost Accounting Practice - Any disclosed or establishedaccounting method or technique which is used formeasurement of cost, assignment of cost to accountingperiods, and assignment of cost to cost objects.

Cost Allocation - A method of assigning costs toactivities, outputs, or other cost objects. Theallocation base used to assign a cost to objects is notnecessarily the cause of the cost. For example,assigning the cost of power to machine activities bymachine hours is an allocation because machine hoursare an indirect measure of power consumption.

Cost Assignment - A process that identifies costs withactivities, outputs, or other cost objects. In a broadsense, costs can be assigned to processes, activities,organizational divisions, products, and services.There are three methods of cost assignment: (a)directly tracing costs wherever economically feasible,(b) cause-and-effect, and (c) allocating costs on areasonable and consistent basis.

Cost Driver - Any factor that causes a change in thecost of an activity or output. For example, thequality of parts received by an activity, or the degreeof complexity of tax returns to be reviewed by the IRS.

Cost Finding - Cost finding techniques produce costdata by analytical or sampling methods. Cost findingtechniques are appropriate for certain kinds of costs,such as indirect costs, items with costs below setthresholds within programs, or for some programs intheir entirety. Cost finding techniques support theoverall managerial cost accounting process and canrepresent non-recurring analysis of specific costs.

Cost Object (also referred to as Cost Objective) - Anactivity, output, or item whose cost is to be measured.

In a broad sense, a cost object can be anorganizational division, a function, task, product,


service, or a customer.

Differential Cost - The cost difference expected if onecourse of action is adopted instead of others.

Direct Cost - The cost of resources directly consumedby an activity. Direct costs are assigned toactivities by direct tracing of units of resourcesconsumed by individual activities. A cost that isspecifically identified with a single cost object.

Estimated Cost - The process of projecting a futureresult in terms of cost, based on information availableat the time. Estimated costs, rather than actualcosts, are sometimes the basis for credits to work-in-process accounts and debits to finished goodsinventory.

Expense - Outflow or other using up of resources orincurring liabilities (or a combination of both), thebenefits from which apply to an entity's operations forthe current accounting period, but do not extend tofuture periods.

Fixed Cost - A cost that does not vary in the shortterm with the volume of activity. Fixed costinformation is useful for cost savings by adjustingexisting capacity, or by eliminating idle facilities.Also called Non-Variable Cost or Constant Cost.

Full-Absorption Costing - A method of costing thatassigns (absorbs) all labor, material, andservice/manufacturing facilities and support costs toproducts or other cost objects. The costs assignedinclude those that do and do not vary with the level ofactivity performed.

Full Cost - The sum of all costs required by a costobject including the costs of activities performed byother entities regardless of funding sources.

Incremental Cost - The increase or decrease in totalcosts that would result from a decision to increase ordecrease output level, to add a service or task, or tochange any portion of operations. This informationhelps in making decisions such as to contract work out,


undertake a project, or increase, decrease, modify, oreliminate an activity or product.

Indirect Cost - A cost that cannot be identifiedspecifically with or traced to a given cost object inan economically feasible way.

Inter-Entity - A term meaning between or amongdifferent federal reporting entities. It commonlyrefers to activities or costs between two or moreagencies, departments, or bureaus.

Job Order Costing - A method of cost accounting thataccumulates costs for individual jobs or lots. A jobmay be a service or manufactured item, such as therepair of equipment or the treatment of a patient in ahospital.

Managerial Cost Accounting System - The organizationand procedures, whether automated or not, and whetherpart of the general ledger or stand-alone, thataccumulates and reports consistent and reliable costinformation and performance data from various agencyfeeder systems. The accumulated and reported dataenable management and other interested parties tomeasure and make decisions about the agency's/segment'sability to improve operations, safeguard assets,control its resources, and determine if missionobjectives are being met.

Opportunity Cost - The value of the alternativesforegone by adopting a particular strategy or employingresources in a specific manner. Also calledAlternative Cost or Economic Cost.

Outcome - The results of a program activity compared toits intended purposes. Program results may beevaluated in terms of service or product quantity andquality, customer satisfaction, and effectiveness.

Outputs - Any product or service generated from theconsumption of resources. It can include informationor paper work generated by the completion of the tasksof an activity.

Performance Measurement - A means of evaluating


efficiency, effectiveness, and results. A balancedperformance measurement scorecard includes financialand nonfinancial measures focusing on quality, cycletime, and cost. Performance measurement should includeprogram accomplishments in terms of outputs (quantityof products or services provided, e.g., how many itemsefficiently produced?) and outcomes (results ofproviding outputs, e.g., are outputs effectivelymeeting intended agency mission objectives?). SeeStatement of Federal Financial Accounting Concepts No.1, Objectives of Federal Financial Reporting, page 65.

Process - The organized method of converting inputs(people, equipment, methods, materials, andenvironment), to outputs (products or services). Thenatural aggregation of work activities and tasksperformed for program delivery.

Process Costing - A method of cost accounting thatfirst collects costs by processes and then allocatesthe total costs of each process equally to each unit ofoutput flowing through it during an accounting period.

Process Value Analysis - Tools and techniques forstudying processes through customer value analysis.Its objective is to identify opportunities for lastingimprovement in the performance of an organization. Itprovides an in-depth review of work activities andtasks, through activity analysis, which aggregate toform processes for agency program delivery. Inaddition to activity-based costing, quality and cycletime factors are studied for a complete analysis ofperformance measurement. Each activity within theprocess is analyzed, including whether or not theactivity adds value for the customer.

Product - Any discrete, traceable, or measurable goodor service provided to a customer. Often goods arereferred to as tangible products, and services arereferred to as intangible products. A good or serviceis the product of a process resulting from theconsumption of resources.

Responsibility Center - An organizational unit headedby a manager or a group of managers who are responsiblefor its activities. Responsibility centers can be


measured as revenue centers (accountable forrevenue/sales only), cost centers (accountable forcosts/expenses only), profit centers (accountable forrevenues and costs), or investment centers (accountablefor investments, revenues, and costs).

Responsibility Segment - A significant organizational,operational, functional, or process component which hasthe following characteristics: (a) its manager reportsto the entity's top management; (b) it is responsiblefor carrying out a mission, performing a line ofactivities or services, or producing one or a group ofproducts; and (c) for financial reporting and costmanagement purposes, its resources and results ofoperations can be clearly distinguished, physically andoperationally, from those of other segments of theentity.

Service - An intangible product or task rendereddirectly to a customer.

Standard Costing - A costing method that attaches coststo cost objects based on reasonable estimates or coststudies and by means of budgeted rates rather thanaccording to actual costs incurred. The anticipatedcost of producing a unit of output. A predeterminedcost to be assigned to products produced. Standardcost implies a norm, or what costs should be. Standardcosting may be based on either absorption or directcosting principles, and may apply either to all or somecost elements.

Support Costs - Costs of activities not directlyassociated with production. Typical examples are thecosts of automation support, communications, postage,process engineering, and purchasing.

Traceability - The ability to assign a cost directly toa specific activity or cost object by identifying orobserving specific resources consumed by the activityor cost object.

Uncontrollable Cost - The cost over which a responsiblemanager has no influence.

Unit Cost - The cost of a selected unit of a good or


service. Examples include dollar cost per ton, machinehour, labor hour, or department hour.

Value-Added Activity - An activity that is judged tocontribute to customer value or satisfy anorganizational need. The attribute "value-added"reflects a belief that the activity cannot beeliminated without reducing the quantity,responsiveness, or quality of output required by acustomer or organization. Value-added activitiesshould physically change the product or service in amanner that meets customer expectations.

Variable Cost - A cost that varies with changes in thelevel of an activity, when other factors are heldconstant. The cost of material handling to anactivity, for example, varies according to the numberof material deliveries and pickups to and from thatactivity.

Variance - The amount, rate, extent, or degree ofchange, or the divergence from a desired characteristicor state.

**************************************************************************************************************THE FEDERAL ACCOUNTING STANDARDS ADVISORY BOARD

The Federal Accounting Standards Advisory Board(FASAB or "the Board" was established in October 1990by the Secretary of the Treasury, the Director of theOffice of Management and Budget (OMB), and theComptroller General. The nine-member Board wascreated to consider and recommend accounting principlesfor the federal government.

The Board communicates its recommendations bypublishing recommended accounting standards afterconsidering the financial and budgetary informationneeds of congressional oversight groups, executiveagencies, and other users of federal financialinformation. The Board also considers comments fromthe public on its proposed recommendations, which are


published for comment as "exposure drafts." The Board'ssponsors then decide whether to adopt therecommendations. If they do, the standard is publishedby OMB and GAO and then becomes effective.

The following documents related to theestablishment and mission of the Board are availablefrom the FASAB:

--Memorandum of Understanding among the GeneralAccounting Office, the Department of the Treasury, andthe Office of Management and Budget, on FederalGovernment Accounting Standards and a FederalAccounting Standards Advisory Board

--Mission Statement: Federal Accounting StandardsAdvisory Board

*******************************************************

The Board expresses its appreciation to Managerial CostAccounting Task Force members listed below for their contributionto developing the Exposure Draft of the Statement.

C. Morgan Kinghorn, Chairman Internal Revenue Service Rein Abel Cost Accounting Standards Board Frank Bankes Navel Sea Systems Command Regina Begliutte Defense Performance Review James Brimson Activity Based Management Institute Debra Carey Department of Interior Tom Cuny Congressional Budget Office Ted David . Department of Agriculture Joseph J. Donlon Internal Revenue Service


Diane Eggert Department of Agriculture Dale Geiger California State University, San Marcos William Gilfillan Department of Veterans Affairs John Glover Department of Defense Dianne Guensberg General Accounting Office Chris Hendrix Ernst & Young Robert S. Kaplan Harvard Business School Joe Kehoe Coopers & Lybrand Richard Loeb Cost Accounting Standards Board Ronald Longo Office of Management and Budget Allan Lund Department of Treasury Pete Poulos Department of Defense Norman Richards General Services Administration Justine Rodriguez Office of Management and Budget Hank Steininger Grant Thornton John Simonette Coopers & Lybrand

Work Group Members:

Clifton A. Williams Internal Revenue Service Richard C. Mayo FASAB Larry J. Modlin FASAB

****************************************************FASAB BOARD MEMBERS


Elmer B. Staats, Chairman

James L. Blum

Donald H. Chapin

Martin Ives

Norwood Jackson

Gerald Murphy

James E. Reid

Cornelius E. Tierney

Alvin Tucker

**********************************************Ronald S. Young, Executive Director

Project Staff:Richard C. MayoLarry J. Modlin

Federal Accounting Standards Advisory Board750 First Street, Suite 1001Washington, D.C. 20002

Telephone (202) 512-7350FAX (202) 512-7366

************************************************END.


Documents

Statement #4/Managerial Cost Accounting Concepts and Standards